What Is a Secured Credit Card & How Does It Work?
If you have a brief credit history or dinged credit, a secured credit card can be a good tool for building credit. Why care about credit health? Because creditworthiness comes into play when applying for most loans and during any employer or other credit check.
A secured credit card allows card holders to try to improve their credit score and demonstrate to lenders that they are trustworthy. If you can’t get a regular “unsecured” credit card, a secured credit card may be a good option.
What Is a Secured Credit Card?
A secured credit card is a credit card that requires a refundable security deposit, which counts as collateral until the account is closed.
Unlike cards that don’t require a security deposit, you need one for a secured credit card to decrease the risk for the credit card issuer, as this is a card for people with damaged or limited credit.
Aside from the cash deposit, you need to provide the credit card issuer with your name, date of birth, income, Social Security number, and address in order to apply. Even if your credit score is 600 or so (fair), you may be able to get a decent secured credit card.
Most secured cards require a minimum deposit of $200 or $300, and that amount is usually equal to your credit limit. If your deposit is on the low end, you’ll want to be careful how you use the card.
Credit scoring models typically penalize utilization over 30%, so if your credit limit is $300, you may want to keep your balance under $90.
A higher deposit will provide breathing room. A deposit of, say, $1,000 boosts the 30% threshold to $300.
Finally, a heads-up if your credit is bad: Unsecured cards targeting people with bad credit are notorious for high fees and confusing terms. And issuers of these cards usually don’t have good cards to upgrade to.
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Pros and Cons of a Secured Credit Card
Like most things in life, there are positives and negatives to this kind of card.
The pros include:
• The ability to rebuild your credit if you have limited or damaged credit.
• A lower credit line so you won’t go over your limit and risk running a high balance.
• Benefits like fraud protection and cash back.
• The ability to switch to an unsecured card with responsible use.
• Potentially lower interest rates than an unsecured card.
The cons include:
• It requires a security deposit.
• It doesn’t come with the same robust benefits as an unsecured credit card.
• The interest is higher than a regular credit card.
• The issuer will need to run a hard inquiry on your credit report.
How Does a Secured Credit Card Work?
When you apply for a credit card, the issuer will run a hard inquiry on your credit report. If you’re approved, here’s how a secured credit card works:
You put down your security deposit, and then you get the same amount to spend as a line of credit.
If you want to increase your limit, you’ll have to contribute more to your security deposit. Secured credit card issuers don’t want to be left in the dust if you decide not to pay—or cannot pay—your balance. If that were to happen, they would just take your security deposit.
People who’ve gone through bankruptcy or are just starting out and have a limited credit history may be suited for this card. It might be a better option than a high-interest unsecured credit card, which those with a low credit score may be approved for.
While it may seem enticing, a high-interest card could take years to pay off and end up damaging a reputation further. A secured credit card poses a much lower risk.
A secured credit card looks the same as a regular credit card on a credit report—so users don’t have to worry about other lenders seeing that they have this type of card. And as long as the balance is paid in full and on time every month, a credit score should start to improve.
After using the card responsibly for a certain amount of time, a secured-card holder might be able to get an unsecured card. One’s secured-card company may switch a card to unsecured as well, allowing access to a higher line of credit without a deposit.
Using a Secured Credit Card
Major credit card companies such as MasterCard, Visa, and Discover offer secured credit cards. This means you can use your card anywhere these brands are accepted.
Some secured credit cards offer benefits like cash back and free access to your credit score.
Many major credit cards also provide liability protection, so you won’t be responsible for fraudulent charges on your account. You may have to pay fees like a monthly maintenance fee, annual fee, balance inquiry fee, or an activation fee.
Though you may be able to get a secured credit card with a lower interest rate than an unsecured credit card, the average rate for secured cards is still higher, at 17.2%., than the average regular credit card interest rate of 16%.
A comparison of different credit cards is in order to see which one has the most appealing terms. However, it’s best not to apply for too many; one hard inquiry can cause a credit score to drop 5 to 10 points . If you apply for more than one or two cards, that could have a negative effect on your credit score.
When you start using your card, paying it on time is going to impact on your credit score rating. If you’re not going to remember to pay it each month, you could set up automatic payments to ensure your bills are up to date. You can also check your credit score every month to make sure it’s trending upward.
Denial of a Secured Credit Card
Even though getting a secured credit card with limited or damaged credit history is possible, an applicant may still be denied.
Anyone who is denied a card should receive a letter from the credit card issuer explaining why. Perhaps they didn’t fill out the application properly and all they need to do is fix it, or their credit score wasn’t high enough.
If the reason has to do with applicants’ credit report, they can get free access to their report through a service like Experian and see their entire credit history.
For example, the credit report may reveal that the credit utilization ratio, or the amount of debt compared with the amount of credit a person has, is too high.
An applicant could start paying down debt more aggressively in order to bring down the credit utilization ratio and have a better chance of being approved for a secured credit card.
Another factor that may cause a denial is if an applicant doesn’t make enough income or can’t prove income. The credit score just may be too low as well.
Tips for Secured Credit Card Approval
Applicants who’ve been denied for a secured card can take steps to try to get approved.
If there is any information on the credit report that doesn’t look right, they can always dispute it. If they can prove that the information is incorrect, they may get it removed.
Applicants could also see if the secured-card issuer will allow a co-signer.
The co-signer would be responsible for paying the debt if the primary card holder failed to do so, and the card would also appear on their credit report. This might make an issuer feel safer approving a card.
If any other lines of credit are open, paying those balances down, and on time every month, can boost a score. And if old lines of credit are open, it’s best not to close them because it can affect the length of one’s credit history—a longer credit history is better. It’s only a good idea to close them if a high annual fee that’s not worth it is involved.
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