A secured credit card requires you to make a cash deposit to the credit card issuer to open your account. With a secured credit card, the amount you deposit, or use to “secure” the account will be equivalent to the line of credit you receive. In other words, a $500 deposit will get you a card with a $500 line of credit.
Read on to learn more about secured credit cards and see if one is right for you.
How Do Secured Credit Cards Work?
Secured credit cards can be used like any other credit card to make payments, and will run on one of the big payment networks like Visa, Mastercard, American Express or Discover. But secured cards are designed for those with limited to no credit or those with damaged credit.
Just like with other types of loans, such as mortgages, auto loans or student loans, credit card issuers use past credit history to determine eligibility and interest rates for their products. The better your credit score, the better your offers will be. That’s because a good credit score signals to lenders that you’re less likely to default or pay late.
But if you have no credit or not-so-great credit, a lender may determine that it’s too big of a risk to approve you for a credit card. Enter secured cards. Lenders who are reluctant to issue credit to borrowers who have struggled financially or are lacking a credit history may be more willing to approve applicants for a secured credit card, as it requires a deposit that can be seized if the debt is unpaid. That deposit is like insurance for the lender if the cardholder fails to make on-time payments.
Each card comes with its own minimum and maximum credit limits, typically starting at a minimum required opening deposit of a few hundred dollars up to several thousand dollars, depending on the card limit and how big of a deposit you’re willing to give.
The Difference Between Secured and Unsecured Credit Cards
There are two types of credit cards: secured and unsecured.
Most secured cards are used as a financial tool to help you boost or establish your credit. The credit limit with a secured card is typically based on how much you put down as a security deposit.
If your on-time payment record with a secured credit card is consistent, the lender may eventually increase your credit limit or offer you an unsecured credit card with more appealing terms and better rewards. If you need to build credit but can’t get approved for an unsecured credit card, a secured card can be a good alternative.
Unlike secured cards, an unsecured card doesn’t require a security deposit and poses a greater risk to the credit card company. These cards are more likely to be approved for those with good to excellent credit. Some of the unsecured cards offered to people with poor to fair credit can have unfavorable terms including annual fees, high interest rates and lack of a rewards program. There are some good unsecured cards on the market designed for those new to credit, like students or those who move to the U.S. for work. But for those who have had credit missteps, the available options may be costly.
Most unsecured credit card products offered to those with good to excellent credit feature lucrative rewards programs, including cash back, miles or points on everyday purchases. There may be some unsecured credit cards that are easily attainable for those with subpar credit, but these usually charge extremely high annual fees and may not offer you a good APR, or interest rate, on your spending.
How to Get A Secured Credit Card
Like any other credit card, the first step is to fill out and submit an application. The lender will then conduct a credit check. The main difference between a secured and unsecured credit card application is that the former will require your bank account and routing number in order to process a refundable security deposit. The amount you deposit becomes your credit limit—the maximum amount you may charge on the card.
Upon acceptance of your security deposit, a secured credit card works just like any other card. Since secured cards do require collateral from borrowers as part of their agreement with the card company, make sure to pay off your balance in-full every month to avoid exorbitant interest charges.
Similar to unsecured cards, your charges will appear on your statement with an amount due for that month. If you decide to cancel the card after an extended period of time, you may receive your deposit back, assuming your balance is paid off.
How To Use Your Secured Card To Improve Your Credit
Making on-time payments is one of the biggest factors that goes into making up your credit score, accounting for 35% of the total. Making your monthly payments on time is key to building up a good credit profile. The best secured cards will report your payments to all three of the major credit reporting agencies (Equifax, Transunion and Experian) so you can eventually graduate to an unsecured card.
The other thing to keep in mind, which can be especially tricky if you have a relatively low credit limit on your secured card, is your credit utilization. Also known as your debt-to-credit ratio, this is the ratio of your total outstanding balance on your card to your overall credit card limit. Your credit utilization makes up 30% of your credit score so it’s a good idea to keep this top of mind when using your card. Ideally, you’d aim to keep this ratio at 30% or less.
Here’s where it can be challenging though. It may not be as hard to stay below 30% on a card with a $10,000 credit limit, as that would mean carrying a balance of $3,000 or less. But on a card with a $500 credit limit, that’s only $150 in charges. If possible, pay off any charges as soon as you can, even if it’s before the end of the billing cycle, to help keep credit utilization low.