Having a credit card tucked in your wallet offers a lot of financial flexibility. Not only can it help in a financial emergency when you’re short on cash, but it can also be necessary for simple tasks like making travel reservations.
Most importantly, it can also help build or rebuild your credit. But if you have a bad credit score (or a limited credit history), you might experience difficulty actually qualifying for a credit card. So, here’s the question: how do you build credit if you can’t get approved for a credit card? The answer: get a secured credit card.
How does a secured credit card work?
Secured credit cards work much like unsecured credit cards. The main difference is that the issuing bank receives extra security in the form of cash collateral. Here’s how it works:
You deposit a predetermined amount of money into the bank, which is held in a bank account that is off-limits to you. The amount required typically ranges between $200 and $500. The amount of your security deposit also equals your credit limit on the secured card. So, for example, a $500 cash deposit would give you a $500 credit limit.
How to Use a Secured Credit Card
You can then charge up to that amount on your secured credit card, using it anywhere a regular card is taken. This includes both online and in-person retailers.
Once your billing cycle ends, and you’re ready for your bill, you should pay off the full charge to prevent interest from accruing. Unfortunately, you can’t use the funds from your escrow account, so it’s really like having an unsecured card.
You must make at least your minimum payment, although paying off your balance in full is ideal. You’ll likely have a high APR, so it’s best to avoid carrying any balance on your secured card. If you get a secured credit card account through a credit union, you might qualify for lower interest rates if you anticipate using your card frequently.
Defaulting on a Secured Credit Card
If you fail to pay your credit card balance, the bank will keep your initial deposit as collateral to reduce their risk. However, if you demonstrate responsible management of your secured card over time, you may be able to upgrade to an unsecured card from the credit card company.
Upon upgrading, you will receive your security deposit back from the issuer. You may not be eligible for a credit card with rewards or additional benefits at this time. However, a secured credit card can be a stepping stone to rebuilding your credit and gaining access to these types of cards.
How to Build Credit with a Secured Credit Card
A secured credit card can help you access credit that you otherwise wouldn’t qualify for. It can also help you improve your credit score if used responsibly. Credit card issuers know that secured cardholders need help building their credit scores, so they generally report to one or more of the three major credit bureaus.
Some may even report to all three: Experian, Equifax, and TransUnion. It’s best to confirm with your bank or credit union before signing up for a secured card. But unlike payday loans, you’ll start to build a monthly history of positive payments, assuming you pay your bill on time.
How does a secured credit card improve your credit history?
Here are some ways that using a secured credit card can help improve your credit history:
- Payment history: One of the most important factors in your credit score is your payment history. By making timely payments on your secured credit card, you can demonstrate that you are a responsible borrower and improve your credit history.
- Credit utilization: Credit utilization is the amount of credit you are using compared to your credit limit. It is typically recommended to keep your credit utilization below 30% to maintain a good credit score. By using a secured credit card and keeping your balances low, you can demonstrate responsible credit management and improve your credit history.
- Credit mix: Having a variety of credit accounts can also be beneficial for your credit score. By using a secured credit card in addition to other types of credit, such as a personal loan or a mortgage, you can show lenders that you can handle different types of credit responsibly.
Using a secured credit card responsibly is key to improving your credit history. If you have any missed payments, late payments, or max out your credit limit, it could have a negative impact on your credit score.
Payment history on your credit report accounts for 35% of your credit score, regardless of whether it is good or bad. That’s the highest allocation out of everything that goes into your credit score.
So using your secured card and making your payments on time will help you build a good credit history. Unfortunately, if you miss a single credit card payment, you will miss out on the opportunity that secured credit cards offer.
How much will a secured credit card raise my score?
It depends on what your credit score is to begin with. There are also many other factors that go into determining your credit score.
However, if you properly manage your secured credit card, it’s quite possible to see up to a200 point increase to your credit score within 12 months. For example, if you have a credit score in the 500s or below, opening a couple of secured credit cards can get you into the 700s within 12 months.
Advantages of Using a Secured Credit Card
- Being able to use a credit card – Obviously, one of the advantages of a secured card is having a line of credit available to you.
- Having the opportunity to build or rebuild your credit – This is the main reason people get a secured credit card.
- No limits on where you can use it – Most banks partner with well-known credit card brands like Visa or MasterCard. This allows you to use your secured credit card anywhere these brands are accepted.
- Lower interest rate – While the interest rate may be high, if you have bad credit, chances are that it will be lower than if you managed to qualify for an unsecured credit card. Plus, secured cards have a low credit limit, which can reduce the temptation to charge large amounts.
- Earn interest on your deposit – Another little-known benefit to having a secured card is that you can oftentimes earn interest on your refundable security deposit, depending on the bank you choose.
It’s wise to shop around for the best secured credit card. Some financial institutions really do try to offer terms that are attractive to both of you. While you can see what’s available with national banks, many community banks and credit unions are better champions for credit building products.
Disadvantages of Using a Secured Credit Card
- Security deposit – A major negative is that you need cash upfront to qualify for a secured credit card. Not only do you have to have at least a few hundred dollars saved up in advance, but you’re also not able to use it while your card is active.
- Your money is tied up – Even if you’re earning a bit of interest on the account, the money is completely tied up. That means you should really focus on creating another level of savings to have on hand so that you’re not counting on your secured card for short-term cash flow issues.
- Annual fee – Another potential disadvantage with a secured card is that some banks require an annual fee, sometimes as much as $50 each year. This can add to the financial burden already required with your deposit. It’s important to find a card that helps you achieve your financial goals, rather than hinder them.
What’s the difference between a secured credit card and an unsecured credit card?
Unsecured cards don’t require a deposit which means they’re more of a risk to credit card companies. They typically require at least average credit. Good or excellent credit is required for the best ones.
What’s the best way to use a secured credit card?
Map out a plan to use it effectively, particularly for the purpose of building credit. First, think about what you’re going to use your secured card for.
If the goal is to build your credit history, consider charging a small amount on the card each month. Then, pay off the full month to avoid accruing interest. The amount you charge is not important. You could simply use the card to pay for your lowest monthly bill and then pay it off immediately after the billing cycle ends.
Upgrading to an Unsecured Card
After you’ve got this pattern down for several months, reach out to your bank to determine when you’re eligible to upgrade to an unsecured card. You might be able to qualify in as little as six months to a year.
Furthermore, find out how quickly you’ll get your security deposit and earned interest back. You can even find out the timeline for upgrading to a better card. This can motivate you to make on-time monthly payments.
Consider Leaving the Account Open
When you get an unsecured credit card, see if the credit card issuer will upgrade your current account rather than opening a new one. That’s because another factor influencing your credit score is your average account age.
Rather than adding a new credit line that brings down your average, you can instead enjoy a longer account period. Finally, keep up a relationship with your bank, especially if it’s local. You might start with a secured credit card, but you can make it easier to qualify for other financial products in the future if the bank is familiar with you.
Secured Credit Cards FAQs
Can I use a secured credit card anywhere?
Yes, you can use a secured card anywhere that accepts credit cards. However, some merchants or service providers may have specific requirements or restrictions on the use of secured credit cards.
Do I get my security deposit back if I close my secured credit card?
Yes, you typically get your security deposit back if you close your secured credit card account. However, you will need to pay off any outstanding balances and meet the terms and conditions of your card agreement before closing the account.
Should I pay my secured credit card in full?
It is a good idea to pay your credit card balance in full each month. It can help you avoid paying interest. Furthermore, it’s not necessary to carry a balance to improve your credit score.
How many times a month should I use my secured credit card?
There is no specific number of times that you should use a secured credit card each month to build credit. As long as you use it responsibly, you will be able to build or rebuilt your credit.
Is a secured credit card the same as a prepaid card?
No, a secured card is not the same as a prepaid card. A prepaid card is a type of debit card that is funded by the user. A secured card is a type of credit card that is backed by a security deposit.