If you’ve ever needed a credit card to rent a car or hotel room, you understand the importance of having one. But for those with poor credit, just getting approved for a credit card may be easier said than done. One option is to get a secured credit card.
With a secured credit card, you provide money up front as collateral. The bank or credit card company that issues the card holds these funds as security, and in return you get a credit card with a credit limit close or equivalent to the amount you paid.
When you make purchases with a secured credit card, you accumulate a balance and are required to make regular payments to the issuer, just like a normal credit card. The bank or credit company takes the security deposit only if you become seriously delinquent on payments, and you may be charged interest on top of that.
Who should get a secured credit card?
When banks assess the risk of extending a line of credit to a customer, they want to make sure the customer can pay it back each month. When that risk is too great, they may ask the borrower to secure the credit card with a small deposit.
By giving money to a credit card issuer to “hold,” borrowers with poor credit are ensuring that their lenders are paid back if the borrowers don’t make their payments.
How to use a secured card wisely
Secured credit cards are great for borrowers trying to establish a credit history.
For example, a young woman just out of college with no credit history may have trouble renting an apartment. When it comes to the credit check, her application may get denied because she has no credit history to check.
With a secured card in hand, follow these tips and you’ll build a healthy credit history:
- Make sure your secured card has a MasterCard, Visa, Discover, or American Express logo. These are the most popular cards available and the ones most likely to be accepted by stores and restaurants.
- Apply only for a secured card that reports account activity to all three major credit bureaus. This way, when a lender pulls your credit report, the credit you’ve built with the secured card will appear on the reports.
- Pay your balance off in full each month. You’ll demonstrate to creditors that you’re a low credit risk and avoid owing expensive interest payments.
Downsides of a secured card
Secured credit cards may be great tools for building or rebuilding your credit, but they have some downsides. The cons you should consider include:
- Some secured cards have high fees, so check carefully for what you have to pay. The best cards have no or low annual fees.
- There may be additional fees for receiving cash advances at an ATM.
- You may be charged for a credit limit increase. Imagine if you arrange with your issuer to change your limit from $500 to $750 and send the additional $250 to cover the difference. The issuer still might hit you with a processing fee for increasing the limit.
- It’s possible to underestimate how interest impacts your balance and subsequently you charge over your limit.
- There are rarely perks, like cash back or travel rewards. While some cards offer them, you’ll probably have to wait on those until you can qualify for an unsecured card.
Getting your deposit back
After using your secured credit card for a while and making your payments on time, your credit may have improved enough that you qualify for a regular credit card.
When you upgrade to the new card, your secured credit card will be closed and your security deposit will be refunded to you in full. Sometimes your card issuer will upgrade your card automatically, but in other cases you may have to submit a new application.
A secured credit card can be useful to someone who hasn’t yet established credit or who has a poor track record with using credit. While secured cards can help, due diligence is always required before signing on the dotted line.