If you have poor credit or no credit history, you likely want to start building your creditworthiness to make it easier to get a loan, rent or buy property, and more in the future.
Credit cards are the quickest and easiest way to build up your credit score. But if you have poor or bad credit and are applying for credit cards, you may wind up with a stack of denial letters. Nearly every credit card company requires a baseline credit score to issue you a regular credit card.
It can seem like an impossible situation. How can you build your credit when you keep getting denied for no or inadequate credit?
Fear not! There’s a path around this credit-building roadblock. Secured credit cards function like normal credit cards, but they have aspects that make them accessible to customers with nearly any credit record.
Let’s explore the secured credit cards and their perks and disadvantages, as well as best practices for secured cardholders.
How does a secured credit card work?
Since a low score or little credit history poses more risk to creditors, secured credit cards require cash collateral that the credit card company can collect in the event payments are not fulfilled.
When applying for a secured credit card, you should expect to fork over a refundable deposit equal to the amount of your spending limit. Put simply: If you put down $600, you get a $600 line of credit on your secured credit card.
After making the deposit, you have a set spending limit and make monthly payments on your balance, just as you would with a normal credit card.
But there’s something important to understand: When you make a purchase, you’re not spending a cent of that $600 deposit. Your deposit is safely tucked away in reserve for the credit card company, just in case you don’t follow through on your payments.
Putting down a deposit equal to your spending limit makes it less risky for a credit card company to lend you money. If you default on your payments, the company will subtract the amount you owe from the deposit. And in some instances, credit card companies will give you a credit line amount that is larger than your deposit, but usually the deposit and credit lines are equal amounts.
If you level up to an unsecured card or close the account, you’ll receive your deposit back from the lender. Depending on the company, you may even receive your deposit after a time (typically 12 months or more).
Secured credit cards vs. unsecured cards
Other than the deposit required by a secured credit card, secured and unsecured cards are basically the same. With both types, you have a spending limit, payment due dates, an interest rate and more.
Secured credit cards tend to have higher interest rates and often come with extra fees. Unsecured cards may offer better interest rates and lower overall fees.
Benefits of a secured credit card
Easy to get approved: If you’ve received an onslaught of denials from unsecured cards, don’t worry. A secured card will more than likely give you the thumbs-up, as long as you pay the deposit.
Your deposit may accrue interest: Some secured card companies put your deposit into an interest-bearing account. If you have a relatively low deposit, interest gained may not be much. But every little bit counts.
Can’t go to collections: If you default on payments to a secured credit card, there is nothing to collect from you besides your deposit, which is then up for grabs. But not being sent to collections doesn’t mean late payments or a default won’t severely damage your credit score.
Disadvantages of a secured credit card
Security deposit: Coming up with funds that you won’t be able to touch for a long period of time may be tough. Just remember that, as long as you make your monthly payments, you get your deposit back.
High interest rates: Secured credit cards often come with high interest rates. Make sure to pay the full amount of your balance each month to avoid interest charges.
Fees, fees and more fees: When shopping for an unsecured card, it’s easy to find cards with low or no fees. The same can’t be said for secured cards. Along with the deposit, expect to pay application fees, processing fees and a yearly fee to carry the card in your pocket.
Secured credit cards vs. prepaid debit cards
Even though you have to put down money for both a secured credit card and a prepaid debit card, the two cards aren’t kin. A prepaid debit card acts like money sitting in your bank, where the balance on your card is the cash in your bank account. You can use up all the money on the prepaid card, and you don’t have to pay it off every month. It’s your money to use and spend as you please.
The spending limit on a secured card is money that you’re borrowing and will have to pay back. You’ll receive your deposit back once the account is closed (provided you don’t default), but the money that you’re spending isn’t your money.
The other key difference between the two is how they affect your credit. Prepaid debit cards have no effect on your credit score. On the other hand, a late payment on a secured credit card can hurt your credit score. (But if you’re making on-time payments, you’ll likely see your credit score jump after a time.)
When can I graduate to an unsecured credit card?
Trust isn’t built overnight. It takes time to prove that you have the capability to handle an unsecured card responsibly.
Sometimes, a secured card company will transition you to a secured card without you requesting. This is usually after a year or two, depending on your situation. Other times, you’ll have to call your company to request the account be switched over to unsecured.
Before you enlist in a secured card, you may want to shop around and ask different companies if they have an option to roll your account over to an unsecured card once you become eligible. Keep in mind: If you have to close your secured card, your credit score may drop, as closing an account can have negative impacts on your credit score.
Using your secured card
Remember that it’s critical to use a secured card wisely. Think of a secured card like a driving instructor that’s required to test you before you can drive by yourself. To pass the test and graduate to an unsecured card, try to do the following: