How Do Secured Credit Cards Work?

Advertiser Disclosure

Do you have bad credit and want to repair it?  Maybe you have no credit history and need a place to start.  One way to build your credit score is by using a secured credit card!  By making monthly payments with a low credit limit, you will gradually be able to improve your credit history and qualify for better banking products in the future!

People get hit by tough times.  Maybe you lost your job or had some unexpected medical expenses.  In the process, you racked up the debt and your current credit score reflects those woes.  Credit cards, even secured credit cards, are not for everybody.  Let’s face it, to qualify for an auto or home loan, you need to have a decent credit score.  Using a secured credit card is not an instant fix, but the odds of getting approved increase dramatically by demonstrating to lenders that you can consistently make monthly payments and carry low monthly balances.

What Is A Secured Credit Card?

Secured credit cards get their name because they require a security deposit to start using it.  Non-secured cards, the most common type of credit cards, do not require a security deposit to use and are only issued to people with fair, good, or excellent credit cards as they are less likely to miss monthly payments.

Secured credit cards work identical as non-secured credit cards but normally have higher fees and lower credit limits.  A secured credit card is a credit card that requires an initial security deposit the same amount as the credit limit.  Credit card issuers require the security deposit in case the cardholder cannot pay the monthly balance, similar to landlords and new renters.  As an example, a secured card with a credit limit of $1,000 will require a $1,000 security deposit that is normally put in a Certificate of Deposit account.  If the cardholder has a balance of $750 for the month and cannot pay it off, then the issuer (aka “the Bank”) will pull from the security deposit to cover the loss.  The bank doesn’t lose any money, but the cardholder still needs to pay off the balance to keep using the card.  If the card is closed, the holder will get the security deposit back minus any outstanding balance.

Although a secured credit card sounds very similar to a prepaid debit card, the secured card has a monthly bill that needs to be paid.  If you miss the due date, the issuer can charge additional fees, interest, and report the event on your credit report (damaging your credit history).  The security deposit cannot pay the monthly balance and is only in place to protect the bank from paying from their own pocket if the cardholder becomes delinquent in payments.

Who Can Use A Secured Credit Card?

Secured credit cards are intended for people with poor or no credit that typically do not qualify for non-secured credit cards.

The following potential credit cardholders might benefit from a secured credit card:

  • Those who have declared bankruptcy or defaulted on a loan within the previous five years.
  • Currently 30 or days late on a credit card or loan payment.
  • Have little or no credit history.

A secured card is great for somebody that wants to build a credit history without the temptation of high credit limits offered by non-secured cards.  A prepaid debit card does not build a credit history, but a secured credit card will.  The secured credit card has a higher initial expense due to the security deposit, but the ability to establish a credit history can be worth it.

How To Choose A Secured Credit Card

Here are some of the best secured credit cards , although your personal bank probably offers a secured card too.

Here are several factors you will want to consider when applying for a secured card:

  • Annual Fee
    • Most cards require a fee ranging from $25-$35 annually.
  • Security Deposit
    • As the security deposit amount determines the credit limit, certain issuers will permit higher credit limits.
  • Interest & Fees
    • Interest rates & fees for secured cards can vary widely between card issuers. If missing a payment is a large concern of yours, consider cards with a lower APR & fee.
  • Rewards
    • Point & Rewards are normally reserved for non-secured cards, but some issuers will put the security deposit into a “high-yield” savings or CD account. It might not amount to much but anything is better than nothing.

As the primary intent for most who have a secured credit card is to build or repair their credit history, you will want to ensure the prospective issuer reports the payment history to the three credit bureaus: Equifax, Experian, and TransUnion.  When applying for a loan in the future, you do not know what bureau the lender will acquire your credit history from so it’s important to verify this before applying for a card, as each application will pull your credit history and temporarily reduce your credit score.

Also, ask the prospective issuer if they will “flag” the credit card as a secured card.  Flagging your card may prevent the credit history from improving your credit score.

You will also want to apply for the highest credit limit possible.  This might depend largely on how much of a security deposit you can afford, but you do not want to “max out” your card every month.  The same principle applies to non-secured credit cards too, but your goal should be to keep your monthly balance lower than 30% of the total credit limit.  For example, your monthly balance shouldn’t be higher than $300 if you only have a $1,000 credit limit.  Keeping the monthly balance below the 30% mark will help improve your credit score quicker.  Making monthly payments is essential, but this practice helps the process.

How Long To Keep A Secured Credit Card

After getting accepted for a secured credit card, the next question is how long you need to make on-time payments before you can either apply for a non-secured card or a new loan.

Your card issuer will periodically review your file and may offer you the opportunity to upgrade to a non-secured card within one year!  You might also start receiving offers in the mail for non-secured cards from other companies.  Of course, you can always monitor your credit score yourself and ask your issuer to upgrade as well.  If they say yes, you can close your secured account and the issuer will refund the security deposit.

With any application for new credit, do not apply for too many at once.  Each application will penalize your credit score & you might have to wait even longer to get qualified for a loan or non-secured credit card.

Leave a Reply