If you’re struggling with a low credit score or a lack of credit, you may realize how hard it can be to be approved for a credit card. Without good credit, big life decisions may become more difficult. Credit is usually needed to buy a car, get a credit card, or be approved for housing options. It may even come into play when you apply for a job.
The good news is that bad or no credit doesn’t have to mean putting your life on hold. A secured credit card could be exactly what you need to get on track.
Let’s start with the basics – what is a secured credit card? It’s all in the name. A secured credit card is a line of credit that is backed by collateral, thereby making it “secured.”
For reference, traditional credit cards are unsecured lines of credit. These accounts require that you have a decent credit history. Once you’re approved, you sign a contract promising to pay back anything you spend on the credit card.
If you have low, bad, or no credit, you may experience (or already have experienced) some difficulty when you apply for traditional credit cards.
Lenders look at your credit history and credit score to determine your level of risk and the likelihood that you will repay your debts. For those with poor or no credit history, the risk level for the lender is usually too high and you are denied for the account.
Secured credit cards are different. The issuer doesn’t offer you a line of credit. Instead, you deposit funds on the card and then use it over time. Because of this, the level of risk is much lower to the lender (or nonexistent depending on the card and the issuer’s terms).
You must make a deposit with the card issuer that acts as collateral. If you fail to repay what you spend, then the card issuer takes the deposit to compensate. Sounds simple enough so far, right? Let’s dig a little bit deeper.
Most secured credit cards follow these steps:
- You apply with the card issuer just like you would with a traditional, unsecured credit card.
- The issuer tells you how much of a deposit you will need, which is based on your credit history and score.
- You make the deposit and that becomes your credit limit. For instance, if you deposit $200, then you have a card with a $200 limit.
- You will spend and repay on that card within the limit. Your deposit stays in your account, untouched by you or the card issuer.
- As you spend and repay, you build credit history and improve your credit score over time (so long as the issuer reports to the three credit reporting agencies – more on this later).
- Eventually, the issuer will return your deposit to you and convert your secured account to an unsecured account.
For those on the fence about using a secured card, understand that there are quite a few important advantages to having a secured credit card. Here are a few examples.
Secured Credit Cards Can Help You Build Credit
If you want to build or rebuild your credit, secured credit cards give you a simple, direct way to do so. It will take time to see an increase in your score, but that’s usually the case for any type of credit-building strategy. Depending on your circumstances, you should see changes to your credit score after a month or two.
You’re More Likely to Be Approved for a Secured Credit Card
If you’re struggling to get approved for a traditional credit card, secured cards have a lower threshold for approval. This is good news particularly for younger consumers and students with little or no credit history.
Today’s credit world is a bit of a catch-22. You must have credit to get credit. The tools available to those with no credit to build the history they need to be seen as creditworthy are lacking – student credit cards and credit-builder loans are about the limit. Secured credit cards make a nice addition to those options.
There’s No Chance of Defaulting With a Secured Credit Card
Every year, millions of consumers find themselves facing collections on their credit card debt because they’re unable to pay off their credit card debt. With a secured card, you never have to worry about that.
This is because your debt is secured by your initial deposit into the account. You can never spend more than the credit limit, which is determined by the deposit amount, and if you fail to pay your debt, the card issuer will just take your deposit as payment (or a portion large enough to cover the debt).
Your Payment History is (Usually) Reported to the Bureaus
Most secured card issuers report your payments to the three main credit bureaus; Experian, TransUnion, and Equifax. This helps you build your credit history and improve your score. As long as you make your payments on time and keep your balance low from month to month, you should see an increase in your credit score.
You Can Graduate to an Unsecured Card
Secured cards can be thought of as training for the “real thing”. In fact, most card issuers will upgrade you to an unsecured credit card after a specified period for you to establish a positive credit history and demonstrate your ability to pay on time.
You can continue to build your relationship with the card issuer, too, as continued use can eventually give you credit increases and access to other perks. Note that this is not the case for all secured cards, though. You’ll need to do your research before applying.
Some Secured Credit Cards Offer Rewards and Perks
Even with a secured credit card, you may be able to take advantage of some rewards and perks usually reserved for unsecured cards. For instance, depending on the issuer, you may earn interest on your deposit.
You may also earn points or miles for your spending on qualifying purchases, and you’ll enjoy protection on purchases, and more. However, understand that this varies a lot from issuer to issuer, and it should be pretty high up on your list of requirements when shopping around for the right secured card.
While there’s a strong case for using a secured credit card to establish or rebuild your credit, there are also some drawbacks to these cards. Here are some of the not-so-great features that come with secured cards.
Secured Credit Cards Require a Deposit
All secured credit cards work the same way when it comes to the collateral that secures the card. You must put down a deposit. That can be hard to do if you’re already strapped for cash, which is a familiar situation for many Americans these days.
While most card issuers will only require $200 to $300, that is little help if you are struggling financially already. However, some card issuers will ask for up to $1,000 down, which puts those cards well outside the reach of those who need them most.
There May Be Fees and Charges
Don’t think that because your card is secured you get off scot-free from paying the fees and charges associated with unsecured credit cards. You will face those, too. However, not all secured cards are the same and each issuer sets its own terms and fee schedules.
What that means for consumers is that you need to be wary. Don’t jump at the first option you find. Shop around and compare your options. Pay close attention to fee schedules, membership costs/annual fees, and even application fees.
Secured Cards Come With Higher Interest Rates
If you’re thinking about using a secured credit card, it means that you probably have no, low, or bad credit. All of those things mean that you represent a high risk to card issuers. While your collateral will secure the card, most card issuers also charge higher interest rates for secured cards than they do unsecured cards.
Higher interest rates mean that your monthly payments will also be higher. However, over time, you should see that interest rate drop as you prove yourself and begin to build or rebuild your credit. Many issuers will also drop your interest rate when the secured card converts to an unsecured card.
Your Credit Limit May Be Lower Than an Unsecured Card
For the vast majority of secured credit cards, your deposit dictates your credit limit. The problem here is that if you only make a small deposit, your credit limit will be correspondingly low. Thankfully, you can usually increase that limit when you convert to an unsecured card.
You May Not Be Able to Upgrade To an Unsecured Card
Not all card issuers will offer a path from secured to unsecured cards. What’s more, their offers can be quite enticing, and you may discover too late that there’s no path forward.
The way to get around this is to research your options before applying for any secured card. Double-check that not only are you able to transition to an unsecured card but that the issuer has a specific strategy to help you do so.
If you’re not sure how to choose the right secured credit card, there are some questions you can ask to help narrow down your choices. Here are five questions that can help you determine which secured credit card is the best option for you.
1. What Fees Are Charged?
As mentioned earlier, you could be on the hook for a host of different fees. Double-check what they are, how much they are, and then compare your options to find a card that works for you but doesn’t cost you a fortune in fees.
2. What’s the Minimum Security Deposit?
Your security deposit is an integral part of the process, but many issuers give you choices. You can put down a minimum, which makes things more affordable but reduces your credit limit, or you can go higher, which costs more but gives more flexibility in terms of spending power.
3. Does the Deposit Dictate Your Credit Limit?
Usually, your deposit is the same as your credit limit, but not always. Verify what your credit limit will be and then compare your choices.
4. How High is the Annual Percentage Rate (APR)?
The annual percentage rate (APR) is basically the cost to use the card. How high is it? Are there cards with lower rates? What are the tradeoffs between them? You’ll likely not have any options with a very low APR, but try to avoid the exceptionally high ones or you could discover that your secured credit card costs you too much to use.
5. Can You Convert to an Unsecured Credit Card?
Here’s the big one. Does the issuer give you the option to convert your secured card to an unsecured card in the future? If not, look elsewhere.
Once you have your secured card, you will want to follow some basic steps to help ensure that you’re able to improve your credit. First, make sure that you use the card. It does you no good if you don’t use it at all.
With that being said, avoid the temptation to make larger purchases that take up the entirety of the balance. Small purchases that you can pay off quickly are a much better option.
Second, make sure you pay off your balance every single month. Don’t roll it over into the next month. You want to show that you’re responsible and financially stable, and paying your balance monthly helps do that. It also helps you avoid those high-interest charges.
Finally, make sure you monitor your credit. You can request your free credit reports from each of the main credit bureaus and use credit monitoring services like IdentityIQ or Credit Karma to stay on top of your credit score and identify areas of improvement.
A secured credit card can be just the tool you need to establish credit or to rebuild your credit. However, not all cards are created equal, and not all issuers are worth your time and money. Shop around, compare your options, and select a card that will help you achieve your financial goals.