If you have a limited credit history or a low credit score, getting approved for a credit card can be a challenge. There is, however, an entire category of credit cards designed for people in this situation: secured credit cards, which can actually help you build or repair your credit score.
A secured credit card (or any kind of secured asset) simply means that the promise to repay is backed by something else of value. In the case of a secured credit card, it’s your cash -- in the form of a security deposit -- which is used to pay your bill if you default. When you put cash up in advance, it’s easier for an issuer to overlook a checkered financial track record and grant you a secured credit card with a modest credit limit. Read on to learn more.
Read more: Best Secured Credit Cards
What is a secured card and how does it work?
A secured credit card requires an upfront deposit, which is usually equal to the credit limit on your card. So if you deposit $300, you’ll typically end up with a $300 credit limit on your card.
Your deposit will be held as collateral by the credit card company. If you don’t pay your bill, the credit card company will use your deposit to cover it -- and most likely cancel your credit card.
If you consistently pay your bill on time, the credit card company may increase your credit limit without requiring you to deposit more money. In turn, it may also refund your deposit after you’ve demonstrated responsible credit card usage. Your deposit will also be refunded once you close your account, assuming you do not hold a balance.
Not all secured cards report to the three major credit reporting bureaus, Experian, Equifax and TransUnion. If you want to improve your credit score, apply for a secured card that will report your credit activity.
Secured vs. unsecured credit cards
An unsecured credit card is a credit card that doesn’t require you to deposit money in case you don’t pay your balance. When people think of a traditional credit card, they have an unsecured card in mind.
A traditional credit card typically doesn’t require you to put down a deposit and it usually has a higher credit limit. But it will also have a higher credit score requirement. Many traditional credit cards also come with rewards and other incentives.
In some cases, you can upgrade your secured card to a traditional credit card after demonstrating a pattern of responsible credit habits.
Pros and cons of a secured credit card
It is generally easy to qualify for.
The required deposit may be small, such as $200.
Some secured credit cards transition good customers to an unsecured card when they show they can handle credit responsibly.
It can help you steadily improve your credit score.
You’ll need to leave your money on deposit; you can’t touch it.
A secured card may charge high fees.
The issuer may perform a hard credit check when you apply, which can ding your credit score.
You have to be careful about how much you charge. Another factor in your credit score is the credit utilization rate, or the amount you’ve charged compared to the total credit available. Credit bureaus like to see credit utilization of 30% or less. If you have a $200 credit level, 30% of that is only $60, so you can’t charge much before you need to pay off the card.
Who is a secured card best for?
Applicants with a limited credit history
If you haven’t used credit often before, there may not be enough information in your credit file to prove that you can be trusted. When you get a secured credit card, the credit card company will report every month to the credit bureaus whether you are paying off the card as agreed. By consistently paying your credit card bill on time and not spending more than your credit limit, you could build up a solid track record.
Anyone with a lower credit score
If you have a FICO score of 580 or below, a secured card can help you improve your credit score. The same activities that help you establish good credit can also help bring up your credit score. Getting a secured credit card, paying the bill in full each month and staying within your credit limit can help raise your low credit score.
With a secured credit card, you’re using credit, even though it’s funded by your deposit. Your credit card usage and payment activity will be reported to the credit bureaus, which can help boost your score over time.
Prepaid debit cards look like credit cards, even down to the Visa or Mastercard logo, but they aren’t credit cards. With a prepaid debit card, you’re not using credit when you buy something. Instead, you load up the card with your money before using it. Since there’s no credit involved, the debit card company doesn’t report to the credit bureau, and you don’t build up your credit file.
Prepaid cards may help you stick to a budget, but they won’t actively help you improve your credit.
After opening a secured credit card account, it will take around one to two months for the secured credit card issuer to report it to a major credit bureau, at which point it will begin impacting your credit report and your credit score. Then it takes several additional months before the account’s activity is substantial enough to make a difference.
If you maintain a low or $0 balance and manage the rest of your finances well, you could raise your score several hundred points in a year or two, but it’ll depend on your particular situation. If you have a longer credit history with a number of issues, it will take longer. If you have a shorter history, each month’s activity will play a much larger role.
Some credit card providers have an option to transition to a traditional, unsecured credit card after you’ve shown you’re responsible with credit. If you want a card with a seamless transition pathway, look for that feature while shopping for a secured credit card.
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