Secured credit cards are an ideal option for individuals aiming to establish or enhance their credit history. These cards function by requiring cash deposits, making them more accessible compared to other credit card types.
This accessibility is particularly beneficial for individuals with limited or no credit history. If you find yourself uncertain about how to begin building or improving your credit history, considering a secured credit card could be a favorable choice.
If used responsibly, a secured credit card can be a valuable resource for establishing a positive credit history. However, before applying for one, it is beneficial to comprehend the mechanics of secured cards.
Continue reading to gain insight into what secured credit cards are and the advantages they can provide.
You Might Also Like:
What Is a Secured Credit Card?
A secured credit card is a specific kind of credit card that requires a cash deposit from the cardholder. This deposit serves as a form of security for the card issuer in case the cardholder is unable to make payments. By obtaining a secured credit card, the cash deposit you provide will determine the credit limit assigned to your card.
Secured credit cards are commonly given to individuals who have a low credit score or a limited credit history. These individuals are often referred to as subprime borrowers or thin-file borrowers. By reporting to credit reporting agencies, secured credit cards provide an opportunity for borrowers to enhance their credit score.
How a Secured Credit Card Works
The majority of credit cards available in the market are unsecured, which means that there is no guarantee or security provided for your ability to repay the balance that you owe to the credit card company.
When you enter into a contract with the credit card company, you agree to make monthly payments towards your outstanding balance, but you are not required to pledge any of your assets or income as collateral for this promise.
This is one of the reasons why credit card interest rates tend to be higher compared to secured debts like mortgages or car loans, as the lack of collateral increases the risk for the credit card company.
The Difference Between Secured and Unsecured Credit Cards
There are two types of credit cards: secured and unsecured.
Secured Card
Secured credit cards are commonly utilized as a means to enhance or establish one’s credit. The credit limit offered with a secured card is generally determined by the amount of the security deposit made by the cardholder.
If you consistently make your payments on time with a secured credit card, the lender may eventually raise your credit limit or provide you with an unsecured credit card that offers more attractive terms and better rewards. If you’re looking to establish credit but are unable to qualify for an unsecured credit card, a secured card can serve as a viable alternative.
Unsecured Card
Secured credit cards differ from unsecured cards in that they do not require a security deposit, which makes them more risky for credit card companies. Unsecured cards are more likely to be approved for individuals with good-to-excellent credit.
However, some unsecured cards offered to those with poor-to-fair credit may have unfavorable terms, such as annual fees, high interest rates, and a lack of rewards programs.
While there are some good unsecured cards available for those new to credit, such as students or individuals building credit for the first time, those who have made credit missteps may find that the available options can be expensive.
Secured credit cards are a popular option for individuals who have less than perfect credit. Unlike unsecured credit cards that are typically available to those with good credit scores, secured credit cards require a security deposit, which acts as collateral for the credit limit.
While unsecured credit cards often come with attractive rewards programs, such as cash back or travel points, secured credit cards may have higher annual fees and less favorable interest rates. It’s important to consider these factors when deciding which type of credit card is best for your financial situation.
How To Get A Secured Credit Card
When applying for a secured credit card, you will need to complete an application form and submit it to the lender. They will then perform a credit check.
The key distinction between applying for a secured credit card and an unsecured credit card is that with the former, you will be asked to provide your bank account and routing number so that a refundable security deposit can be processed.
The deposit you make will determine your credit limit, which is the maximum amount you can spend on the card.
Once your security deposit is approved, a secured credit card functions similarly to any other card. These types of cards are typically designed for individuals with poor credit scores and may have high annual percentage rates (APRs). To prevent excessive interest fees, it is crucial to pay off the entire balance each month.
Just like unsecured credit cards, the charges you make with a secured credit card will be listed on your monthly statement along with the amount you owe. It’s important to note that your deposit acts as a security and allows you to make purchases up to your credit limit.
However, you are still required to make the minimum payment each month. If you carry a remaining balance, you will be charged interest and your available credit limit will be reduced by that amount.
If you choose to cancel the card while maintaining a good account status or if you qualify for an unsecured card, you may be eligible to receive your deposit back, provided that your balance is fully paid off.
How To Use Your Secured Card To Improve Your Credit
Ensuring timely payments is crucial in determining your credit score, as it contributes to 35% of the overall score. By consistently making your monthly payments on schedule, you can establish a favorable credit profile.
Top-notch secured credit cards have the advantage of reporting your payments to the three major credit reporting agencies (Equifax, Transunion, and Experian), which allows you to advance to an unsecured card in the future by showcasing responsible financial habits.
When using a secured credit card, it is important to consider your credit utilization. This refers to the ratio of your outstanding balance on the card to your overall credit limit. It plays a significant role in determining your credit score, accounting for 30% of it. Therefore, it is advisable to keep this ratio at 30% or lower to maintain a good credit score.
However, there can be difficulties in maintaining a low credit utilization ratio. It may be relatively easier to keep it below 30% on a credit card with a $10,000 limit, as this would mean carrying a balance of $3,000 or less.
On the other hand, for a card with a limit of $500, this would only be $150 in charges. If feasible, it is advisable to pay off any charges promptly, even if it is before the billing cycle ends, in order to keep the credit utilization ratio low.
Pros of secured credit cards
A secured credit card might be right for you if:
You’re looking to establish or build credit
If you are looking to enhance your credit scores or establish a credit history, a secured credit card can be a beneficial choice. These cards are supported by a cash deposit, which makes them more accessible to certain borrowers due to their less strict approval requirements compared to unsecured cards.
You don’t mind paying a refundable deposit
A secured credit card is a type of credit card that requires you to make an initial cash deposit. However, you can get your deposit back when you decide to close your account, as long as you have paid your balance in full and on time every month.
You want to work your way up to an unsecured credit card
Secured credit cards serve as a pathway towards obtaining approval for an unsecured credit card. By demonstrating responsible credit usage and enhancing your credit scores, you may eventually be eligible to switch to an unsecured credit card.
Certain issuers of secured credit cards may choose to refund your initial deposit and upgrade your account to an unsecured card if you consistently demonstrate responsible credit habits over a specific period of time.
Cons of secured credit cards
Like any type of credit card, secured cards are not without their risks. Secured credit cards tend to have:
High fees and interest rates
When it comes to secured credit cards, there is a possibility of encountering steep charges for application, processing, or annual fees. Moreover, these particular cards often come with elevated interest rates due to credit card companies anticipating a higher number of defaults from individuals with lower credit scores.
Low credit limits
Secured credit cards have a credit limit that is usually determined by the amount of your security deposit. This can be a disadvantage if you have plans to make substantial purchases, as the credit limit might be relatively low.
Having low credit limits can potentially raise your credit utilization rate, which is the proportion of credit you use in relation to the total credit available to you. This is typically represented as a percentage. Maintaining a credit utilization rate of 30% or lower can positively impact your credit scores.
In order to maintain a good credit utilization rate with a secured credit card, it is important to keep your monthly spending below $100 if your credit limit is $300 and you have paid a $300 deposit. This means that you will need to have the necessary funds upfront to cover your expenses.
You’ll need to have cash up front
Having a credit account can be advantageous because it allows you to access funds that you may not have otherwise. However, if you are facing financial constraints, it can be challenging to manage the deposit required for a secured credit card.
Is a secured credit card right for me?
If you are considered a borrower with a higher level of risk or if you are facing difficulties in establishing or improving your credit history, it may be beneficial for you to consider obtaining a secured credit card.
However, it is important to ensure that you have the necessary funds to cover the initial deposit required.
Using a secured credit card can be beneficial for enhancing your credit score in the long run. However, it’s important to note that your actions with this type of card, whether positive or negative, can impact your credit reports.
Therefore, before obtaining a new credit card, make sure you have the confidence to handle it responsibly and make timely payments.
Secured credit cards are a great option for building credit history, especially for those with limited or no credit. It’s important to understand how they work and consider the differences between secured and unsecured cards before applying.
I agree that having cash upfront is important when using a secured credit card. It’s crucial to carefully consider if a secured credit card is the right option for your financial situation before applying.
Secured credit cards are a great option for individuals with limited or no credit history. They provide an opportunity to establish a positive credit history and can be a stepping stone towards obtaining an unsecured card with better terms. It’s important to understand the mechanics of secured cards and consider factors such as annual fees and interest rates before