What is a secured credit card, and how it boosts your credit score
A secured credit card works like any other credit card, but with one big difference: it requires you to put down a deposit before you can use it. The amount you deposit usually matches your credit limit. So, if you put down $300, that’s how much you can spend on the card. This deposit makes the card “secured” because the lender can take the money if you don’t make your payments.
People with limited or poor credit are the ones who usually benefit from secured credit cards. Traditional credit cards can be hard to get if you’ve had financial troubles in the past or if you’ve never had a credit card before. A secured card gives you the chance to show lenders that you can be responsible with credit, even if your credit history isn’t great. The card reports your payment history to the major credit bureaus, and if you use it responsibly, it can boost your credit score over time.
How secured credit cards work
The main thing that sets secured credit cards apart is that you need to put down a deposit to open one. Once you’ve made your deposit, the card works just like any other credit card—you can use it for everyday purchases, pay your bills, and even earn rewards, depending on the card. Each month, you’ll get a bill that shows how much you’ve spent and how much you need to pay.
What makes secured credit cards particularly useful is that they report your payment activity to the credit bureaus. This means that if you consistently make your payments on time and keep your balance low, your credit score will improve. Eventually, after proving you’re reliable with your payments, you might even be able to switch to an unsecured credit card, where you won’t need to put down a deposit anymore.
Step-by-step process to apply for a secured credit card
Step 1: Consider your options
Applying for a secured credit card isn’t complicated, but there are a few things to keep in mind. Start by looking at different options. Some cards have no annual fees, while others might offer rewards or lower interest rates. Choose one that fits your financial situation.
Step 2: Fill out the application
Once you’ve picked a card, you’ll need to fill out an application. It’s usually an online process, and you’ll have to provide basic details like your income and employment status. Even though secured cards are easier to get, the issuer might still check your credit history before approving you.
Step 3: Deposit after approval
After you’re approved, you’ll need to make your deposit. This deposit is your credit limit, so think about how much you’re comfortable putting down. Some cards require a minimum of $200, while others might ask for more.
Step 4: Keep in mind the fees
Finally, make sure you know about any fees the card may have, like an annual fee or charges for late payments. These fees can affect how much credit you have available, so it’s good to understand what you’re signing up for.
Top 5 benefits of secured credit cards
Secured credit cards offer several valuable benefits, particularly for individuals looking to build or rebuild their credit. These advantages go beyond just being a financial tool and can provide long-term gains in personal finance management.
Credit building and repair
One of the main reasons people opt for a secured credit card is to build or repair their credit. Since secured cards report to the major credit bureaus—Experian, TransUnion, and Equifax—your responsible usage is reflected in your credit report. If you make your payments on time and keep your balances low, this helps boost your credit score. Over time, this will make it easier to qualify for unsecured credit cards, loans, or even better interest rates on mortgages. This makes secured credit cards a stepping stone for many who need to demonstrate creditworthiness.
Control overspending
Unlike unsecured credit cards that can tempt you to overspend with high limits, a secured card’s limit is based on your deposit. If you put down $300, that’s how much you can spend. This forces you to stay within a fixed boundary, which can help with budgeting and avoiding debt. It provides a safe way to use credit without risking more than you’ve deposited, ensuring that you live within your means while still enjoying the convenience of a credit card.
Perks and rewards
Even though secured credit cards are mainly designed for credit building, some of them offer perks similar to unsecured cards. These can include cash-back rewards, points for purchases, or even travel rewards. Although not as extensive as the perks on unsecured cards, they add value for users who are just getting back on their feet financially. Rewards can often be an added incentive to use the card regularly, especially for day-to-day purchases.
Credit score monitoring
Many secured credit cards come with credit score monitoring tools as part of their services. This feature allows you to keep track of your credit score’s progress as you use the card responsibly. It provides real-time feedback on how your credit actions are influencing your score, which is invaluable if your main goal is to improve your creditworthiness.
Comparison with other credit-building tools
When you compare secured credit cards to other credit-building tools, like credit-builder loans, secured cards offer more flexibility. With credit-builder loans, you make fixed monthly payments that are only reported to the bureaus, but you don’t get the convenience of being able to spend like you do with a secured credit card. Secured cards allow you to use credit daily while still working on your credit score, offering a practical and versatile solution.
The fees and costs associated with secured credit cards
While secured credit cards are a valuable credit-building tool, it’s important to understand the fees and costs associated with them to avoid surprises.
Annual fees
Many secured credit cards charge an annual fee, which can range anywhere from $25 to $50. This fee is taken out of your available credit, which means that if your limit is $300, your real available credit could be $275 or less, depending on the fee. It’s important to factor this in when considering how much to deposit and how much credit you’ll actually have to work with.
APR rates
Secured cards often come with high annual percentage rates (APRs), which can be as high as 20-25%. This is the interest charged on any balance you carry over from month to month. While secured cards can help build credit, carrying a balance and paying high interest can work against your financial goals. To avoid high interest costs, it’s a good idea to pay off your balance in full each month.
Setup and maintenance fees
Some secured cards may charge setup fees or monthly maintenance fees in addition to the annual fee. These costs can reduce your available credit or eat into your deposit. For example, a setup fee of $30 may be deducted from your deposit, meaning you’ll have less credit available to spend.
Over-limit and cash advance fees
In addition to setup and maintenance fees, some secured cards also have over-limit fees if you exceed your credit limit or cash advance fees if you use your card to withdraw cash. These fees can quickly add up and reduce your available credit, so it’s essential to be aware of them before applying.
Different ways secured credit cards help you build credit
Secured credit cards are specifically designed for those looking to establish or rebuild their credit. Here’s how they can help.
On-time payments
Making timely payments is one of the most critical factors in building credit. Every month, the card issuer reports your payment history to the credit bureaus. By consistently paying at least the minimum payment on time, you establish a record of responsible credit use. Over time, this improves your credit score, opening up better financial opportunities.
Low credit utilization
Another key factor in improving your credit score is keeping your credit utilization low. This refers to how much of your credit limit you’re using. For instance, if your credit limit is $300, it’s a good idea to keep your balance below $90 (or 30%) to demonstrate responsible credit use. Low credit utilization signals to lenders that you’re not overly dependent on credit.
Reporting to credit bureaus
Since secured credit cards report your activity to the three major credit bureaus, every on-time payment and responsible credit usage is recorded. Over time, this positive credit history will be reflected in your credit report, leading to a higher credit score.
An example of building credit
For example, if you use a secured credit card for a year, making all payments on time and keeping your balance low, you could see your credit score improve by 50 to 100 points, depending on your overall credit profile. This improvement could then qualify you for an unsecured card with better terms, marking your progress on the credit-building journey.
How secured credit card deposits work
The deposit you provide for a secured credit card plays a crucial role in how the card functions.
The role of the deposit
The deposit serves as collateral for the card issuer. This means that if you fail to pay your bill, the card issuer can use the deposit to cover the amount owed. Your deposit also determines your credit limit. For example, if you deposit $400, your spending limit will be $400. This deposit secures the card, making it available to individuals with bad or no credit.
Getting your deposit back
You can get your deposit back in two situations: if you close the account in good standing (with no outstanding balance) or if your issuer upgrades you to an unsecured credit card after demonstrating responsible credit behavior. In both cases, the deposit is refunded to you.
Losing your deposit
However, if you default on your payments—meaning you fail to make the required payments—the issuer can take part or all of your deposit to cover the balance. This reduces their risk and is why secured cards are accessible to individuals with damaged credit histories.
Automatic upgrades
Some issuers will review your account after several months of responsible use. If you’ve proven your creditworthiness, they might automatically upgrade you to an unsecured card. When this happens, you’ll get your deposit back, and you may even qualify for a higher credit limit without needing to provide additional funds.
Tips for choosing the right secured credit card for your needs
Choosing the best secured credit card depends on your financial goals and personal needs. Here are some factors to consider.
Low or no fees
Look for a secured credit card with minimal fees. Some cards charge no annual fee, while others may have a small fee. Avoid cards with excessive setup or maintenance fees, as these can reduce your available credit and make the card more expensive to use.
APR rates
If you anticipate carrying a balance, choose a card with a lower APR. While many secured cards have high interest rates, finding one with a lower APR can save you money if you can’t pay off your balance in full each month.
Upgrade policies
It’s important to select a card issuer that offers a clear path to upgrading to an unsecured card. Some issuers automatically review your account after six months to a year, while others require you to request an upgrade. Knowing the issuer’s upgrade policy can help you plan for the future.
Rewards programs
If you want to earn rewards on your spending, look for secured cards that offer cash back or points. While these rewards may not be as generous as those on unsecured cards, they can still provide value for everyday purchases.
Customer service
Good customer service is essential when managing your secured card account. Look for a card issuer with a reputation for clear communication and accessible customer support, whether through an app, phone, or website.
Secured credit card vs. unsecured credit card
When deciding between a secured and unsecured credit card, it’s important to understand the differences between the two.
Requirement for a deposit
The key difference is that secured cards require a deposit, while unsecured cards do not. This deposit acts as collateral, making the secured card easier to obtain for those with poor or no credit.
Credit limits
With secured cards, your credit limit is tied to the deposit amount. Unsecured cards, on the other hand, base your credit limit on your credit score and income. If you have a good credit history, unsecured cards typically offer higher limits than secured cards.
Interest rates and fees
Secured cards often have higher APRs and fees compared to unsecured cards. Once you build your credit with a secured card, you may qualify for an unsecured card with a lower APR and fewer fees, making it a more cost-effective option.
Who should choose which
If you’re starting from scratch or recovering from financial hardship, a secured card is the safer choice. However, if your credit score is already solid, an unsecured card will offer more benefits and flexibility, without the need for a deposit.
How to transition from a secured to an unsecured credit card
For many cardholders, the ultimate goal is to move from a secured credit card to an unsecured one. This transition offers numerous advantages and signals improved financial stability.
What issuers look for
Issuers generally look for consistent on-time payments and responsible credit usage when considering an upgrade from a secured to an unsecured credit card. Typically, if you make at least six months to a year of on-time payments, maintain a low credit utilization rate, and avoid delinquency, the card issuer may initiate a review of your account. This shows that you’ve managed your credit responsibly, reducing the risk for the issuer. During this review, they assess whether you’re a good candidate for an unsecured card, which requires no deposit.
Refund of deposit
Once the card issuer deems you eligible for an upgrade, your deposit will be refunded. The exact timing of this refund can vary, but it’s usually returned as soon as the issuer approves the transition. This can free up your deposit for other financial goals or savings, offering you greater liquidity.
Advantages of transitioning
Transitioning to an unsecured card has several benefits. First, it frees up your deposit, allowing you to regain access to the funds you initially tied up as collateral. Second, an unsecured card often comes with higher credit limits, which can improve your credit utilization ratio—a key factor in boosting your credit score. Lastly, unsecured cards generally offer better terms, such as lower APRs and fewer fees, making them a more cost-effective tool for managing your finances.
Final words
Secured credit cards offer a simple and effective way to build or rebuild credit. By understanding how they work, including their benefits, fees, and the transition process, you can make informed decisions that help improve your financial standing. Whether you’re just starting out or recovering from past financial issues, using a secured credit card responsibly sets you on the path to better credit and greater financial freedom in the future.
FAQs
What is the difference between a secured credit card and a debit card?
A secured credit card lets you build credit by borrowing money, backed by your deposit, while a debit card uses your own funds from a bank account. Debit cards don’t affect your credit score since they don’t involve borrowing.
What is the difference between a secured credit card and a prepaid credit card?
A secured credit card helps build credit because it reports your payments to credit bureaus, while a prepaid credit card does not. With a prepaid card, you’re using your own money, similar to a debit card, and it won’t improve your credit score.
How much is the limit on a secured credit card?
The limit on a secured credit card typically matches your deposit. For example, if you deposit $300, your credit limit will be $300. Some issuers allow for higher deposits, leading to higher limits, depending on your financial situation.
Can you get denied for a secured credit card?
Yes, even though secured credit cards are easier to get, you can be denied if you have recent bankruptcies, very low income, or if the issuer determines you’re too risky based on your credit history.
Will using a secured credit card increase my credit score?
Yes, if you use a secured credit card responsibly—by paying your bill on time and keeping your balance low—it can gradually increase your credit score, as your positive credit behavior gets reported to the credit bureaus.
Understanding How Credit Behavior Gets Reported to the Credit Bureaus
Credit behavior plays a crucial role in determining your credit score and overall financial health. It’s important to understand how your financial activities and habits are reported to the credit bureaus, as this can impact your ability to secure loans, credit cards, and even affect rental applications.
What is Credit Reporting?
Credit reporting refers to the process by which credit bureaus collect and maintain information about your credit history. This information is used to create your credit report, which lenders and other financial institutions use to assess your creditworthiness.
- Credit reports include details about your credit accounts, payment history, outstanding debts, and any public records such as bankruptcies.
- Credit bureaus like Experian, Equifax, and TransUnion are the primary agencies responsible for compiling and maintaining these reports.
How Does Credit Behavior Get Reported?
Your credit behavior is reported to the credit bureaus by creditors and lenders. This includes information on:
- Payment History: Whether you pay your bills on time or have missed payments.
- Credit Utilization: The ratio of your credit card balances to your credit limits.
- Length of Credit History: How long your credit accounts have been active.
- Types of Credit: The variety of credit accounts you have, such as credit cards, mortgages, and loans.
- New Credit Inquiries: The number of recent inquiries into your credit report, which can impact your score.
Why is This Important?
Understanding how your credit behavior is reported can help you make informed decisions about managing your finances. By maintaining good credit habits, you can improve your credit score, which can lead to better interest rates and financial opportunities.
For more information on how to manage your credit and improve your credit score, visit Consumer Financial Protection Bureau.