A secured credit card is different from a regular credit card. You’ll need a cash security deposit for a secured credit card. The security deposit reduces the risk of the issuer. This makes secured cards a good option for individuals with bad credit. Secured credit cards are used to build credit. If you have trouble getting approval for an unsecured card, you can apply for a secured credit card to improve your credit score. The card is designed specifically for individuals with a bad credit score.
The deposit acts as a protection to the lender or bank if the cardholder defaults on payment. If you don’t make payments on a secured credit card, the credit card company will use the deposit to cover the payment.
How Do Secured Credit Cards Work?
A cash deposit has to be made to the creditor to open a secured card. The cash deposit is placed in a secure account by the creditor.
The secured account cannot be accessed by the cardholder until the card is active. If payments are missed, the lender withdraws from the account to pay for the overdue balance.
One of the important things that you need to remember is that a secured card isn’t a prepaid card. You aren’t withdrawing the cash deposit each time you use the card.
You’ll have to pay the balance or the minimum amount or a portion of the balance before the due date. This is similar to how you use an unsecured credit card. If monthly payments are missed, the creditor uses the deposit to pay for the balance.
When payment default happens the effect on the secured card is the same as that on an unsecured credit card. If you don’t use the secured card in a responsible way, it can negatively impact your credit score.
Factors to Consider When Choosing a Secured Credit Card
The most important factors that you’ll need to consider when choosing a secured credit card include:
The initial deposit
The credit limit
The annual fee
The initial deposit and the annual fees are expenses that you’ll have to bear even if you don’t use your secured credit card. The credit limit of the card will influence your credit score.
The initial deposit has to be paid before the secured card is opened. The amount varies depending on your credit history. The amount usually ranges between $250 and $500.
The deposit amount can be 50% to 100% of the card’s credit limit. The deposit is an up-front expense that won’t be available until the account is closed.
The credit limit on secured cards is usually lower than that of unsecured cards. Your credit limit will increase only after you have established a history of making on-time payments. You’ll be able to lower your credit utilization ratio when the credit score improves.
A secured cardholder’s payment history is reviewed after 6 to 12-months. Your credit score will improve if the payments have been made on time.
The annual fee on secured cards is charged directly to the balance. It’s done either as one large sum or divided into small monthly installments. The annual fee begins on the day the card is opened.
You’ll be able to save money and protect your credit score if you choose a secured card with a low annual fee and initial deposit.
The other factors that you’ll need to consider when choosing a secured credit card include:
Annual percentage rate (APR) or penalty APR
Additional fees such as initial processing fees and monthly maintenance fees
Credit bureau reporting
How to Use a Secured Credit Card?
A secured credit card can be used in the same way as an unsecured card. Your card can be used to make different purchases or for travel purposes. The lower credit limit is the one big difference between secured and unsecured cards.
When using a secured card, you should limit the use of the card to below the available limit. When you keep the balance low compared to the available limit, you’ll be able to build your credit score in an effective manner.
Keep the utilization ratio as low as possible. It’s also a good idea to pay the balance in full before the due date. When you make regular payments on time, the issuing bank will report positively to the major credit bureaus.
A secured credit card can go a long way in building a positive credit score. If you start using your secured card in a responsible manner, you’ll be able to improve your credit score and financial standing.
Benefits of Using a Secured Credit Card
Getting approval for a secured credit card is much easier than an unsecured card. Even though there are many unsecured cards available, getting approval requires a good credit score.
As the secured card is backed by a cash deposit, it’s easier to get approval. You’ll be able to get approval even if you have bad or no credit.
Secured cards charge fewer fees each year. Unsecured cards charge higher annual, processing and maintenance fees.
If you pay the full balance before the due date, you’ll incur no or minimal interest charges. Secured cards are an effective tool for building a good credit score.
The initial deposit that’s made is refundable if all balance payments are made and the account is closed.
If payments are made on time, the lender can choose to change the secured card to an unsecured card. Your deposit is refunded in such a scenario.
Always pay on time when you use a secured credit card. It’s important to remember that it takes months to build a good credit score. A couple of late payments will adversely affect the credit score.
If you start using your secured credit card carefully, you’ll be able to improve your credit score within a year. You can then become eligible to apply for an unsecured card.
Interested in learning more about secured credit cards? Check out our credit card guide! It goes into detail about secured credit cards and other options that you have.