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.

using a secured credit card

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 your 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?

A secured credit card offers you the perks of a normal credit card, while 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 an account that is off-limits to you. The amount required typically ranges between $200 and $500. You can then charge up to that amount on your secured credit card, using it anywhere a normal 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 in order to prevent interest from accruing. Unfortunately, you can’t use the funds from your escrow account, so it’s really like having a normal credit card.

You must make at least your minimum payment, although paying off your entire balance is ideal. You’ll likely have a high APR so it’s best to avoid carrying any balance on your card. If you get a secured card through a credit union, you might qualify for lower rates if you anticipate using your card frequently.

If you default on the credit card balance, the bank keeps the money you originally deposited, so the risk is greatly reduced for them. When you’ve responsibly managed your secured credit card for a certain period of time, you can upgrade to a regular credit card from your financial institution.

When that happens, you’ll receive your deposit back. You might not yet qualify for a card with a robust rewards program or other perks, but you won’t need that cash collateral in order to get approved. A secured credit card is a stepping stone to re-entering the world of credit.

Can you improve your credit score with a secured credit card?

Not only does a secured credit card give you access to credit when you wouldn’t otherwise qualify, it also helps you to boost your credit score — when used responsibly. Banks and credit unions know that secured cardholders need help building their credit, so they generally report to one or more credit bureaus.

Some may even report to all three: Experian, Equifax, and TransUnion. It’s best to confirm with your financial institution 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 this reporting process help your credit score? The largest percentage of your credit score actually depends upon how consistently you pay your debts each month. Any late payment that is 30 days or more overdue can be reported to the credit bureaus.

lady holding credit card

You then get a separate negative entry every subsequent 30 days that it’s late. So if it takes you three months to pay one student loan bill, you get three separate negative item, with each one hurting your score. And while many creditors report your late payments, they don’t always bother reporting your on-time ones.

Whatever type of payment history you have on your credit report — whether good or bad — it represents 35% of your credit score. That’s the highest allocation out of everything that goes into your credit score.

So to have the chance of getting your on-time payments for a secured credit card captured on your credit report can be extremely helpful. But it also underscores just how important it is to make all of your credit card payments on time so you can take full advantage of this opportunity.

What are the advantages to getting a secured credit card?

Obviously, one of the largest advantages of a secured credit card is having a line of credit available to you. Next to that is the chance to rebuild your credit score each month. While these are important enough reasons on their own, there are a few more perks when you get a secured credit card.

One is that there aren’t limits on where you use them. Most banks partner with well-known credit card companies like Visa or MasterCard, allowing you to use your secured credit card anywhere these brands are accepted. It’s an extremely convenient financial tool.

While you might have a higher interest rate, chances are that it will be much lower than if you managed to qualify for an unsecured credit card. Plus, secured credit cards start off with a relatively low credit limit, so you don’t have the temptation to charge huge sums of money.

This can be extremely helpful if your bad credit resulted from overspending or lack of financial planning. Another little-known benefit to having a secured credit card is that you can oftentimes earn interest on your deposit, depending on the bank you choose.

While the yield might not be huge at first, over time it could add up a bit. So while you’re building your credit and using your card, you know that the required deposit money isn’t being held hostage — it’s actually working on your behalf.

This is another example of why it’s important 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.

What are the disadvantages of getting a secured credit card?

Shopping around is not only ideal to get the best terms for your secured credit card, but also to find a financial institution that actually offers them. This isn’t a product that’s considered a staple for every single bank, so the disadvantage is that it takes some extra digging to find exactly what you’re looking for.

Do your research so you can find the best deal, even if it’s more time-consuming than you’d like. The other major negative here is that you need cash up front to qualify for a secured credit card.

Not only do you have to have at least a few hundred dollars saved up in advance, you’re then not able to use it while your card is active. If that’s all you have as savings, your credit card becomes your emergency buffer, not your cash.

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 credit card for short-term cash flow issues.

Another potential disadvantage with a secured credit 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 secured credit card that helps you achieve your financial goals, rather than hinder them.

What’s the difference between a secured credit card and a prepaid debit card?

A prepaid debit card can be used in similar ways as a secured credit card, but with a few key differences. You get the same flexibility in where you use it because a prepaid debit card is typically branded with a major credit card issuer like Visa or MasterCard.

But rather than paying for a deposit and charging, you simply load the card up with the amount of funds you wish to use. You can even link your prepaid card to your checking account in some cases. Most commonly, though, prepaid debit cards are used by individuals without bank accounts.

One of the downsides with a prepaid debit card is that you can be charged a lot of fees. For example, there’s usually a card activation fee and a monthly maintenance fee (although that can sometimes be waived if you sign up with direct deposits).

man holding credit card

You could also be charged every time you take cash out of an ATM or even make a purchase. Depending on your usage of the card, these fees can really start to add up.

The biggest difference between a prepaid debit card and a secured credit card is that none of your debit card information is reported to the credit bureaus. That means it doesn’t build your credit score. Instead, it basically helps you access the convenience of using a debit card rather than cash, especially if you can’t get a bank account.

On the other hand, you don’t need much upfront money to get a prepaid debit card and you can use whatever money is loaded on the card. It could be a good way to shop online or avoid using cash.

What’s the best way to use a secured credit card?

Once you decide that a secured credit card is a good choice for you, map out a plan to use it effectively, particularly for credit building purposes. First, think about what you’re going to use your secured credit card for.

If you want to use it to rebuild your credit history, consider charging a small amount on the card each month, and then pay off the full month to avoid accruing interest. The amount doesn’t matter, so you could use it just for your cheapest monthly bill, then repay it as soon as the billing cycle ends.

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.

Also, 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 at the beginning of your card usage because that can serve as motivation for making those on-time payments each month.

Another tactic to use when upgrading your secured credit card is to ask the bank to issue another card, rather than closing the old account. That’s because another factor influencing your credit score is your average account age.

Rather than adding a new account 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 off with a secured credit card, but you can make it easier to qualify for other financial products in the future when the bank is familiar with you.