Secured credit cards present a great opportunity to build or rebuild your credit history. With a low security deposit, you can start adding positive information to your credit history.
People who have had trouble with credit in the past or young adults who have never had credit before might find a solution in a secured credit card. This guide explains how secured credit card work, answers common questions about secured credit card, and shows how to choose a secured credit card. Learn the drawbacks of secured credit cards, the best way to use a secured credit card to build or rebuild credit and the most important mistakes to avoid with a secured credit card.
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What’s in this guide?
- What is a secured card?
- How secured credit cards work
- How to choose a secured credit card
- Drawbacks of secured credit card
- The best way to use a secured credit card to rebuild credit
- Important mistakes to avoid
- Frequently asked questions
What is a secured credit card?
Most credit cards are granted solely on your credit history, income, and a promise to repay what you purchase on the card. The credit card issuer doesn’t require any upfront payments before they will approve your credit card applications. Even annual fees are billed to your account rather than being due before you can open the card.
A secured credit card, on the other hand, requires a security deposit to be made against the credit limit for the card. The credit limit is usually equal to the amount of the security deposit. If you make a $500 security deposit, for example, you will have a $500 credit limit.
Besides the security deposit, your secured credit card behaves just like a regular credit card. Your purchases are charged against the credit limit and you’re required to make at least the minimum payment each month. Your security deposit is held in case you default on your payments. As long as you pay as agreed, your security deposit will be returned to you.
How secured credit cards work
Some consumers have a tough time getting approved for a credit card because they’ve had past credit problems or haven’t established a credit history yet. Some credit card issuers offer secured credit cards for these consumers. The security deposit that secures the credit limit shifts some of the risk from the credit card issuer and offers collateral in case the cardholder defaults on the credit card agreement.
For the most part, applying for a secured credit card is much like applying for any other credit card. Along with your application, you must include the information for your security deposit – checking account number, bank routing number, and amount of the security deposit. Upon approval, the credit card issuer transfers funds for the security deposit into a savings account and opens your credit card account.
Purchases increase your credit card balance and lower your credit limit, leaving you with less credit available for purchases. Each month, you’re required to make at least the minimum payment on your credit card balance. Your security deposit is not used for making regular credit card payments.Back to top
How to choose a secured credit card
Choosing the right secured credit card is important for making sure you end up with a card that will help you rebuild your credit score.
- Minimum security deposit. If you don’t have a lot of money to put towards a security deposit, you’ll want a secured credit card that will allow you to pay a low security deposit. You’ll be able to get a secured credit card without having to come up with a lot of money.
- Maximum security deposit. Perhaps you have several thousand dollars and want a secured credit card with a large credit limit. In this case, look for a secured credit card that allows a high security deposit. Many limit the security deposit to $5,000, but there are a few that allow security deposits as high as $10,000.
- Annual fee. Annual fees are common with secured credit cards. As you compare secured credit cards, look for one with a low annual fee. This will lower the cost of having a secured credit card.
- Interest rate. Ideally, you will pay your balance in full each month. This is the best way to build a good credit score and avoid getting into debt. If there’s a chance that you’ll carry a balance rather than pay in full each month, choose a secured credit card with a low interest rate. You’ll pay less in finance charges if you have a low interest rate.
- Reporting to the major credit bureaus. The goal of having a secured credit card is to build a new credit history or rebuild a bad credit history. Having a card that reports your account details to the major credit bureaus is a must. This way your payment history will be included in your credit report and will help improve your credit score.
- Upfront fees. The best secured credit cards do not charge any upfront fees. You’ll only have to pay your security deposit to receive your credit card. Tread carefully with any credit card that asks you to pay additional fees to get a credit card.
- The credit card issuer. Picking a secured credit card from a major credit card issuer is often a safe choice. Choose a secured credit card from a well-known, reputable credit card issuer to be sure you’re not falling for a scam.
Drawbacks of secured credit cards
While secured credit cards are a great solution for people with limit options for access to credit, there are some drawbacks to secured credit cards that you should consider before you apply for one of these cards.
- A security deposit is required. It may be hard for some people to spare a few hundred bucks, especially at once and for something that’s not a necessary expense. If you can’t afford to pay the security deposit right away, consider putting aside $25 to $50 each month until you’ve save up enough money for the security deposit.
- Your credit limit is based on your security deposit. If you can’t afford to make a large security deposit, you’ll have to learn to manage a low credit limit. You won’t have much room to make purchases, especially since it’s best for your credit score if you keep your credit card balance below 30% of the credit limit. That’s $60 on a credit card with a $200 credit limit.
Credit limit increases may not be available. Since your credit limit is based on your security deposit, you may be stuck with the credit limit you have when your account is opened. Some credit card issuers may allow you to make an additional deposit to increase your credit limit and others may not.Back to top
The best way to use a secured credit card to rebuild credit
Ideally, your secured credit card is only a stepping-stone to a better credit card. In the meantime, it’s important to use your secured credit card in a way that improves your credit score. Otherwise, it will take you longer than necessary to qualify for an unsecured credit card.
- Choose a secured credit card that reports to the major credit bureaus. A card that reports to all three major credit bureaus – Equifax, Experian, and TransUnion – is best, but if the card only reports to one credit bureau, that’s ok as long as the rest of the terms are favorable.
- Always make your payments on time. Payment history is the most important factor affecting your credit score. It makes up 35% of your FICO score. Remember that you’re trying to rebuild a bad credit score. You can’t afford even a single late payment.
- Keep your balance at a reasonable level. The amount of debt you’re carrying is the second most important factor for your credit score – counting for 30% of your credit score. The lower your balance, especially relative to your credit limit, the better. Aim to charge no more than 30% of your credit limit.
- Minimize any other applications for credit. Credit card issuers judge you based on the number of credit applications you make. Keep your secured credit card as your primary credit card for six months to a year so you build a positive credit history. Then, consider applying for another credit card once you’ve begun to re-establish your credit.
Mistakes to avoid with a secured credit card
Paying late, especially defaulting on your card credit card agreement. Paying late on a secured credit card can have a few consequences. You’ll face late fees. If you’re more than 60 days behind on your payment, your interest rate may increase. The late payment will hurt your credit score and could keep you from qualifying for other credit offers. If you default on your credit card by falling several months behind, you could lose your security deposit.
Charging a high balance. High credit card balances hurt your credit score and are more difficult to pay off. Keep your credit card balance below 30% of the credit limit to demonstrate good credit card habits so you can qualify for better credit in the future.Back to top
Frequently asked questions
What happens to my security deposit?
The credit card issuer holds on to your security deposit, similar to the way a landlord would hold a security deposit for a rental home. The credit card issuer will place your deposit into a savings account; in some instances you may earn a small amount of interest on your deposit. Your security deposit is unavailable as long as your account is open. Your deposit will be returned to you if you make all your payments on time and keep your account in good standing. On the other hand, if you default on your credit card, the card issuer will keep your deposit.
Do secured credit cards report to the major credit bureaus?
Whether your secured credit card reports to the major credit bureaus depends on the credit card you choose. Secured credit cards from the major credit card issuers will almost always report to the three major credit bureaus. Before you apply for a secured credit card, make sure you confirm that it reports to the credit bureaus. This is the only way your credit card usage will help your credit score.
Can I be denied for a secured credit card?
While secured credit cards do approve many applicants with bad or no credit history, there are some consumers who may get denied for a secured credit card. For example, if you’ve had a recent bankruptcy discharge or you don’t have enough income to repay a credit card balance, you can be denied for a secured credit card.If you’re denied, the credit card issuer will send a letter telling you the reasons you were denied. You can use this information to apply for your next credit card.
How much will I need for a security deposit?
You’ll generally need between $200 and $300 for the minimum security deposit depending on the secured credit card you choose. You can pay a higher security deposit to receive a higher credit limit. The maximum security deposit ranges from $5,000 to $10,000 depending on the credit card.
How are secured credit cards different from prepaid cards?
Because of the initial deposit requirement, many people confuse prepaid cards and secured credit cards. However, the two cards are very different. A prepaid card isn’t a credit card at all. You’re not given a credit limit that you can make purchases against. Instead purchases are deducted from the amount you’ve deposited onto the card. Because there’s no credit involved, prepaid cards do not affect your credit history, good or bad.
Secured credit cards on the other hand are credit cards in every sense of the definition. Your purchases are made against a credit line and your credit history is reported to credit bureaus. The difference is that you’ve made a deposit to serve as collateral for the balance on the card not for spending.
Do secured credit cards have high fees?
Many secured credit cards have an annual fee and may have a higher interest rate than unsecured credit cards. Some secured credit cards may charge a small application fee. Be wary of secured credit cards that charge an upfront fee other than the security deposit and application fee. Compare secured credit cards to choose be sure you’re not choosing a card with higher than normal fees.
How can I convert to an unsecured credit card?
After you’ve made several months of timely payments, many secured credit cards will convert your account to an unsecured credit card. It may take a minimum of 12 months to build a solid payment history and be considered for an unsecured credit card. If your credit card doesn’t convert after you’ve paid on time, you can try applying for an unsecured credit card. Your positive payment history with your secured credit card will improve your chances at getting approved.
How quickly will my credit score improve?
It’s hard to pinpoint how quickly and how much your credit score will improve after using a secured credit card. It depends on the other information in your credit report and how you stack against consumers with similar credit profiles to you. You can monitor your credit score progress, but keep in mind it takes time to build a good credit score, especially if you have negative information to overcome.