What you need to know about subprime cards

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If you have a good or excellent credit score, you should have no problem getting a credit card with a good interest rate, and you likely will qualify for the best offers, such as interest-free periods.

Those with no credit or a low credit score, however, may have to sign up for a subprime credit card.

"Subprime credit cards are credit cards offered to clients who are considered a high credit risk," Elena Jara, director of education at Credit Canada Debt Solutions, said in an emailed response to questions. "This type of credit card product charges a high interest rate, and provides a low credit limit; thus, is low-risk to the lender."

Here's what you need to know about subprime credit cards - and how they can actually help build your credit score.

What is the difference between prime and subprime?
To understand what a subprime credit card is, it helps to understand the prime rate.

The prime rate is the best interest rate offered by a lender to its most credit-worthy customers. The prime rate is used to set the interest rate on various borrowing products, including variable rate mortgages, lines of credit, student loans and some credit cards.

"The major advantage of getting a bank's prime rate when borrowing money is that you'll save money on interest since you're borrowing money at a lower interest rate," Brenda Hiscock, certified financial planner at Objective Financial Partners, said in an emailed response to questions.

When you're a subprime borrower, it means that you have a substandard or limited credit history. Because of your lower credit score, you'll have difficulty getting approved for standard credit cards.

However, you have options. Some major lenders and smaller financial institutions offer credit cards specifically for subprime borrowers.

Subprime cards are easier to get now
Subprime borrowers have been signing up for credit cards in droves over the last two years, and lenders have been more lenient about approving subprime borrowers. According to credit reporting agency TransUnion, 14 per cent more subprime borrowers gained access to credit cards between the first quarter of 2015 and the first quarter of 2017.

With a subprime card, you're not going to get the best interest rate or the highest credit limit, and you likely won't qualify for long 0 per cent interest offers.

Beware the marketing for subprime cards
If you aren't in the market for a credit card (for example, if you are trying to improve your debt situation), beware subprime credit card marketing.

Lenders may send you "pre-approved" card applications in the mail, Jara said, when in fact, you haven't been pre-approved. Or you may see ads that claim to guarantee a credit card despite bad credit or no credit, she said.

Don't be easily swayed to sign up for a subprime card. Check out the subprime card's rates and terms - in fact, always do your homework on any card - before you apply.

"Many consumers follow the recommendations of friends and family members and don't bother to do the research on what options they have available," said Jara.

When a subprime card can be helpful
A subprime card can be a good financial tool, if you use it wisely.

Similar to a secured credit card, a subprime credit card can be used to build your credit score. A subprime card can be helpful if you are new to credit, or if you are recovering from past credit mistakes.

By using your credit card responsibly and only making purchases you can afford to pay off in full, you can improve your credit score and eventually qualify for a standard credit card and other credit products with decent interest rates.

A good credit score comes mostly from good repayment behaviour and a low credit utilization ratio (how much credit you have available versus how much you use). Other factors, such as credit mix, length of credit history and recent credit inquiries, make up much smaller portions of your score.

Don't return to (or enter) a debt hole
Although subprime credit cards can be useful, there's always the risk that you could make your financial situation worse.

"If you have a poor credit score because you've abused credit in the past, unless you can change your past spending behaviours, you'll more than likely find yourself further in debt and could further lower your credit score," said Hiscock.

Because subprime cards have a higher interest rate than typical standard credit cards, if you carry a balance, it will cost you a lot.

Subprime credit cards also tend to come with extra fees and lower credit limits. The lower credit limit may be good to help you avoid racking up too much debt, but if you exceed your credit limit, you'll more than likely pay a higher interest rate. This can make your debt even more difficult to erase.

Therefore, if you apply for a subprime card, use it responsibly. You can start building (or rebuilding) your score and, later, get a card with a better interest rate, a higher credit limit and even a good rewards program. Soon you will be on your way to being a credit maven.

See related: Why you shouldn't use a credit repair company, Application denied: 6 reasons for credit rejection
Published August 3, 2017

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