If you’re starting to think about buying a house and you’ll need a mortgage, your credit score is the first thing to consider.
Your credit score will tell mortgage lenders how reliable you are as a borrower by looking at your track record of paying off debts in the past.
Find out how to check your credit history.
A good credit score can mean a better rate on your mortgage, and will generally make it easier for you on your journey to home ownership. On the other hand, Whilst it might seem like never needing to borrow money or buying on credit would be a good thing, actually having no credit history is almost as bad as having a bad one, so it’s important to try and built it up. Credit cards are a good way of doing that.
What is a credit card?
A credit card is a type of bank card. You use it in the same way as you would a debit card, except instead of paying using your own money you’re borrowing money from the bank.
You then pay it back every month – you’ll receive monthly statements from your credit card provider showing your outstanding balance (total that you owe), the minimum payment due, the interest rate and the due date of your next payment. Usually the card will have an ‘interest free’ period, so as long you pay back the full amount during that time, you won’t need to pay any interest. If the interest free period runs out, you’ll start paying back more than you borrowed.
Credit cards are good for building up a credit score because they allow you to borrow small amounts of money regularly and pay it back on time, demonstrating your reliability at very little risk to you.
Things to consider when choosing a credit card
There are a number of things you should look at when you’re looking for your first credit card.
Representative APR
APR stands for Annual Percentage Rate and is the cost of borrowing for a whole year, including fees and interest.
Representative APR means the APR that at least 51% of customers receive– so almost half might not. The actual APR is decided by your credit history as well as your general financial situation. Unhelpfully you’re often not told what your APR will be until you receive the card, but it’s good to bear in mind that you might not get the APR they advertise.
Some banks will tell you what your APR is before you get a credit card through them. For example, Barclays will provide you with a personal rate if you already bank with them.
Introductory APR
Bear in mind that the APR you receive at the start may not be the rate you receive forever – you may be switched to a standard variable rate which tends to be much higher. It’s important to find out whether this will apply to you, and consider whether it’s suitable.
Credit limit
The credit limit is the maximum amount you can borrow at any one time. As with APR, this is judged on your financial history and you usually won’t be told until you’ve signed up. But they might be able to give you a rough estimate, so always ask.
Bear in mind that it doesn’t look good to use all the credit that’s available to you. The percentage of your available credit that you use is known as your ‘credit utilisation ratio’ and will be used to judge how secure your financial situation is.
For example, if you have a credit limit of £500 and you use it all, your credit utilisation ratio will be 100% and it may be an indicator that you’re financially stretched.
However, if you use £100, your credit ratio will be 20% and it implies your financial situation is comfortable.
You should aim to use 20-30% of your limit, so bear this in mind when getting an estimate for your credit limit. Your credit limit is often increased the more the lender trusts you, so if you’ve been with them a long time, they may increase it. Similarly, you can ask to lower your credit limit so that you haven’t got a £5000 limit for a £30 payment for your phone every month.
Minimum repayments
You should aim to pay off your entire loan at the end of each month, but this might not be possible if you have purchased a larger item and are paying it off (e.g. furniture or flights). However, in order to protect your credit score and interest rates, you should always pay off the minimum monthly repayment. Find out how much this is so you can think about whether it’s realistic for you. You can set up a standing order or bank transfer to pay it off every month if it’s recurring payment.
Fees and charges
You’re doing this to improve your credit score, so hopefully you won’t miss any payments or exceed your credit limit. But it’s good to be aware of what the fees will be if you do, as you don’t want to spiral and accumulate more debt. For practical reasons it’s also good to be aware of other fees, for example the cost of withdrawing money abroad.
What card should you get?
If you’ve never had a credit card before you won’t have much of a credit history, so your best bet is to apply for a credit builder credit card.
They are designed for people with poor, or no, credit history. As they’re designed for people who are deemed more of a risk to the credit card company, the interest rates will be higher than the standard rates. As long as you repay what you owe each month then you won’t need to pay any interest anyway, but it’s worth considering just in case something happens and you find yourself unable to pay off the full amount at the end of the month.
Often these cards have a low credit but this will go up as you prove you can manage it responsibly. As you spend credit and then pay it back on time, you’ll slowly build up a good credit history.
Once you've decided on what type of card you need, all that remains to do is apply for it.
Credit cards are great way to build up your credit score, and there are credit cards specifically designed for that purpose. But, as with any borrowing, you should read the small print and be sure that your financial situation is secure enough.
More ways to improve your credit score.