Bad credit or no credit, it can be hard to get an issuer to cut you some slack. Secured credit cards are a good option for those who ready to start building or re-building credit.
Think about it: if you have bad or no credit, lenders see you as a risk. With no credit history, there’s no evidence to show that you will repay your debt. Even worse is a bad credit history. Would you lend money to someone who has a record of not paying it back? Even close friends and family would have a hard time getting you to hand over that cash.
Now imagine if your uncle, who in the past hasn’t been paying his debts, comes to you for money. But first, he hands you a hundred dollars, then asks to borrow fifty dollars. You would probably agree, and leave fifty bucks richer.
That’s the basic idea of a secured credit card.
In real life, nobody, uncle or otherwise, would do that because it doesn’t make a whole lot of sense. Why give your lender just as much or more money than you’re going to borrow, when you could just keep all your cash? Well, in the case of secured credit cards, the reason is right in the name. You are getting a genuine credit card when no one else will give you one.
Essentially, what you are doing is paying for the privilege to have a line of credit. In turn, your lender will report your credit activity to the major credit bureaus, which over time rebuilds your credit and raises your credit score. After some time passes, your credit will be high enough for you to graduate to a better, “real” credit card.
Some people disparage secured credit cards as being functionally like prepaid cards, in terms of cash in-flows/out-flows, and as you can see, this is sort of true. But that line of thinking misses the point. If your credit score has taken a beating, you shouldn’t be in the mindset of looking for more “real” credit. You should be taking hold of your finances, accumulating cash and security, and rebuilding your reputation with lenders.
Don’t be spooked away from credit cards just because you made mistakes in the past. Without a good credit score, you are going to be paying out the nose in interest rates on future loans such as mortgages, auto loans, etc. Not to mention that most hotels, airlines, and rental car agencies require a credit card to make reservations. Those who take debit cards usually require a deposit. Even many employers use credit scores to gauge potential employees for hire.
How It Works
Enough of theory. Let’s get down to specifics.
- When you open a secured credit card, you put down some cash. Ever had to pay a security deposit when you signed a lease? It’s the same idea. In the case of an apartment, if you took care of the property and left it clean and undamaged, you got your deposit back. Otherwise, your landlord took some or all of your deposit to pay for the damage. It works the same way with a secured credit card. If you pay all your credit card bills on time, you will get your deposit back when you close the card.
- Typically, your credit limit will be no higher than your deposit, and sometimes it will even be less. Some cards allow you to increase your credit limit by putting down more money into your deposit, while others will increase it after you’ve made consistent monthly payments for a certain period of time.
- The card issuer usually won’t tap into your deposit after just one or two late payments. But if you fall seriously delinquent (think about 150 days), they will close your account and take the deposit. By that point, interest charges have likely caused your balance to exceed your deposit, so not only is your credit worse than before, but you have additional debt. This is not a pretty road. Don’t go down it.
Getting a Secured Credit Card
- The most important thing when looking for a secured credit card is that the card issuer will report your credit activity to the major credit bureaus. Absolutely do not apply for any secured card that does not do this for you, because that’s the entire point. Reporting your activity is what will rebuild your credit.
- Compare interest rates, fees, and all other costs. Secured cards are a market of their own, and good lenders will be competing with each other to secure your business. Since so many people with bad or no credit are feeling desperate, many card issuers take advantage of that by charging ridiculous fees and interest rates. Just say no to such schemes.
- With that said, many will charge processing fees, application fees, and annual fees. You probably can’t avoid annual fees, but try to find one with no application fee.
- Secured credit cards typically have higher APRs than normal cards.
- Some secured cards will put your deposit into an interest-bearing account.
- Check whether the card you’re interested in will allow you to convert it into a normal card after a certain period of time. This is a nice thing to have, but not necessary.
- Credit unions often have the most favorable fee schedules for secured credit cards, so give your local one a look.
- Sometimes secured cards can even come with a rewards system! This is a nice bonus, but it should be a low priority, since fees can easily undo rewards.
Obviously, it pays to compare and contrast many secured card options before making a decision. Here’s one we like to get you started, the Capital One Secured MasterCard. Good luck!