Secured Credit Cards
If you don’t qualify for a traditional credit card because you have no credit history, secured credit cards are a great way to get your toes wet and learn how credit works. Sometimes, it’s the only way to get a second chance at breathing again if you’re drowning in debt.
With secured credit, you get all the convenience and privilege of a traditional (unsecured) credit card, but only after making a cash deposit as collateral to secure the card issuer against any loss. Secured cards are offered by nearly every bank and card company that issues traditional cards, but the most attractive offers (i.e. least expensive fees) might be the ones offered at credit unions.
The cash deposit typically ranges from $200 to $500 and almost always equals the credit limit assigned to that card. In other words, if you make a $300 deposit, you likely will have a $300 credit limit on your card.
Be aware that the deposit is not intended to be applied to the monthly charges, unless you default on payment. You are expected to pay whatever charges you incur at the end of every month. If you don’t, that is when your deposit is applied and very likely, your card gets canceled.
Secured credit cards also open the door for people who made mistakes managing debt and need to re-establish their creditworthiness. Credit card companies look at responsible use of secured credit cards in a favorable light. Most are willing to let a consumer graduate back to an unsecured card if they prove they can handle a secured credit card responsibly.
Secured Credit Cards vs. Prepaid Debit
Most secured credit cards report account information to all three credit bureaus, thus helping you start a credit history or re-establish one.
Prepaid debit cards do not report to credit bureaus. They are loaded with money and used in a similar way to standard debit cards, though prepaid cards are not associated with a bank account.
Secured cards could be an ideal way for college students to get in the game. They learn how to use a credit card without having to pay too large a penalty for mistakes. The credit limits will keep purchases at a reasonable level and the cash deposit acts as an affordable backstop if things spiral out of control.
Advantages of a Secured Credit Card
Secured credit cards operate almost identically like traditional credit cards. They are a back up when you don’t have cash for a purchase. They can help you create or improve your credit history. You can use them to make payments almost everywhere. You receive monthly billing statements detailing what you bought and how much you owe. There is a deadline for payments.
The major difference is the deposit you make that actually makes the secured card secure. That deposit is not applied to monthly charges. If you make only a minimum payment, interest rate charges will apply on the balance.
Perhaps the biggest benefit is that responsible use can lead to approval for an unsecured credit card (i.e. one with no deposit required). That should be the goal for anyone using a secured credit card.
Other advantages of a secured card include:
- It is accepted anywhere traditional credit cards are accepted, thus providing the same convenience.
- It allows the card holder to build a credit history in a controlled environment. The credit limits on secured cards are usually lower than traditional cards, which should help keep spending down.
- It will help you establish a credit score if you have never had one, or improve your credit score if it needs some repair work.
- It allows you to purchase products only available online and can be used to secure reservations with hotels and car rental agencies.
- It serves as an emergency backup for those times when you don’t have enough cash or a check available for an unexpected expense.
The best thing to do when you receive a secured credit card is use it for the same purposes you would a traditional card. Experts suggest you apply the same utilization rate as an unsecured card, meaning limit your purchases to 30% or less of the available credit. That will have a positive impact on your credit score.
Most importantly, make your monthly payments on time. Whether you’re trying to build a credit history or re-establish one, the single biggest factor in your favor is on-time payments.
If you make on-time payments every month, your credit score could reach an acceptable enough level (generally higher than 630) to obtain an unsecured credit card in a year or less.
Disadvantages of Secured Cards
There is a reason secured credit cards are not the preferred method of credit. For all the advantages in building credit, there are quite a few limitations.
Saving up for the initial deposit can be difficult while still managing other bills. Plus, a security deposit takes away any advantage credit gives you. Credit enables a consumer to budget for something he/she could not afford with cash. Anything purchased with a secured card would be covered with the cash used in the initial deposit.
The very thing that defines a secured credit card is also its biggest disadvantage. There isn’t any reason to have a secured credit card if you can qualify for an unsecured card. It’s best to think of it as a training program creating good money habits for when you upgrade to an unsecured card.
Secured cards can carry application fees, processing fees as well as annual fees. Be sure to compare fees while shopping around for the cheapest card.
Higher Interest Rate
Interest rates are generally higher for secured credit cards because card companies don’t have to offer competitive rates. Nearly two-thirds of secured credit cards have an interest rate over 20%. It’s important to pay off the balance each month to avoid costly interest.
Low Credit Limit
Available credit is restricted to the security deposit. More than likely that limit will be under $1,000 which will make it difficult to finance something expensive like a nice, new laptop. Then again, it’s best to pay cash for that because of the higher interest rates.
Secured Card Upgrade
Many companies that issue both secured and unsecured credit cards, will allow you to graduate to an unsecured card. After a period of time, they’ll review your account to see if you qualify for an upgrade. If you do, they will refund your deposit and issue an unsecured card.
If your company doesn’t do upgrades, check your credit score and if it’s above 630, you could qualify for an unsecured card from one of the major banks or card companies.
Warning Signs for Secured Credit Cards
There are some things every consumer should be mindful of when investigating secured credit cards.
First, make sure the company that issues the secured card reports activity to the major credit bureaus: Experian, TransUnion and Equifax. Most secured cards do report, but there are still a few that don’t. If you are trying to establish or improve your credit score, you’re wasting your time if spending and payments aren’t reported to the credit bureaus.
Carefully read the conditions for each card and take note of interest rate charges and any fees that could be applied. Generally speaking, the interest rates on secured cards are higher than those for traditional credit cards. Also, most secured cards have fees — sometimes several fees — tied to the card. Activation, annual, late payment and cash advance fees are just a few of the added charges that could change your mind about a card.
Be sure there is a “grace period” for making payments. A grace period starts on the final day of the billing period and ends on the due date. That time frame should be at least 21 days, with most cards offering a 25-day grace period. If there is no grace period, you will pay interest on a purchase as soon as the card gets swiped. That can be costly over the course of a billing period.
Finally, you should investigate the card issuer’s policy on returning the deposit. Some companies offer to pay interest on the deposit. It’s nice to take a little cash home with you when you’re ready to move on to an unsecured card.
Build Good Habits with Secured Credit Cards
Low credit scores can entrap users by preventing them from getting new credit card accounts, which prevents users from building up their credit scores. That’s where secured credit cards come in.
When looking for a secured credit card, begin by finding out your credit score because you may already qualify for an unsecured credit card, which has far more benefits than an unsecured card. Federal law provides for one free credit report every year from each of the three credit bureaus. Talk to your bank, if you have one, and see whether you qualify for a secured or unsecured card.
If you must go the secured card route, go online and compare the offers available. Some secured cards have no annual fee, some have no activation fee, some have varying interest rates and some give you a bonus like providing your credit score every month.
A security deposit can range from $200 to $10,000, though it’s rare to go anywhere over $1,000. At the beginning, your credit limit is equal to or lower than your deposit. You can raise your credit limit by adding to the deposit down the road.
Secured cards generally have a lower credit limit than traditional credit cards, which prevents users from taking on more debt and doing more damage to their credit scores. Even if your credit limit is initially low, you can build good habits by making small purchases and paying them off at the end of every month. Experts recommend limiting purchases to less than 30% of the credit that is available in your account.
In order to show major credit card companies your ability to properly use credit, you will want to make your monthly payments on time. This activity on your account should be reported to the credit bureaus, and your credit score should start to rise.
Be certain to read the offer information on a secured credit card to ensure that they are reporting your activity to all three credit bureaus. It is important to make sure that the information is accurate and that banks are reporting your positive account activity (“good standing”) in a timely fashion.
Your credit limit can be raised after keeping the account in good standing for six months or more, depending on the bank.
Some cards report good standing even when purchases are not made on the account. By keeping these cards at a zero balance, you can build your score without any hassle. Some banks will even offer interest on your security deposit.
Pay on Time and Avoid Defaults
Just as practicing good habits with a secured credit card has benefits, returning to bad spending habits with a secured credit card has consequences.
Payments must be on time or interest will be charged on balances kept in the account. If minimum payments are not made, late fees may be added.
The inability to pay your monthly bill may result in losing the deposit and possibly the account. The security deposit stays in the account while it is open, but can’t be applied to the monthly balance.
If you can’t make a payment within a specified time — it varies
from card to card, but 30–60 days after the due date is a common time frame – you will default and several negatives kick in: frame — you will default and several negatives kick in:
- The default will be reported to the three credit bureaus and damage your credit score.
- Your card will be cancelled and no more charges will be approved.
- Your deposit will be applied to settle the unpaid balance.
- If there is any deposit money left over, you have to call or write the lender to request a refund.
Closing a Secured Credit Card Account
If you are ready to close a secured credit card account, you can call or write the bank or card company to inform them, but the most important step is to make a final payment and get the balance down to zero.
If you don’t talk to your bank or card company about your desire to close the account — and presume they’ll just take the final balance out of your deposit — you may end up paying several penalties and have negative activity reported to the credit bureaus.
It isn’t necessarily a bad idea to close a secured credit card. Most of the time it is wise to close the account as soon as you become eligible for a traditional credit card, but as always, there are some mitigating circumstances to consider before running away.
A secured card helps you establish a credit history, one of the five major factors involved in determining a credit score. If you have a secured card for 12–18 months and then switch to a traditional card, you lose the 12–18 months of history you had and start all over again.
If you are looking for a loan to make a major purchase, your credit score will come into play and you wouldn’t want to do anything that has a negative effect on it. Thus, you may want to keep the secured card account open, until you have built up a credit history with the traditional card.
However, if you aren’t looking for a loan immediately, there is no reason to keep the secured account open. You not only would eliminate the monthly fees that accompany most secured cards, you also would have access to the deposit money that stands behind your secured card.
About The Author
Max Fay has been writing about personal finance for Debt.org for the past five years. His expertise is in student loans, credit cards and mortgages. Max inherited a genetic predisposition to being tight with his money and free with financial advice. He was published in every major newspaper in Florida while working his way through Florida State University. He can be reached at [email protected].
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