When building your credit from zero, getting started can seem like the impossible dream. After all, how do you build credit when you can’t get credit?
Rebuilding your credit after a tumble can be a challenge as well. Lenders are reluctant to take on risk and rates can be high.
A secured credit card answers both dilemmas, helping new borrowers build credit and helping others to rebuild credit.
What is a secured credit card?
With a secured credit card, a deposit backs the debt. This contrasts with most credit cards, which are unsecured. With most cards, if you can’t pay, the credit card company doesn’t have any collateral against the debt.
The lender can’t easily collect anything else to satisfy the debt. For example, a car secures the debt for an auto loan. A house secures the debt for a mortgage.
Secured credit cards differ from standard credit cards because they use a deposit as security for the credit line, not unlike an auto loan or a mortgage. Secured credit cards reduce risk for the lender, so you’ll find it easier to get approved for a secured card when compared to a traditional credit card.
Easier approval makes a secured credit card a valuable tool if you’re just getting started in the credit world. A secured card can also help people who need to rebuild their credit. It’s easy to confuse secured credit cards with some other types of cards, however.
In particular, watch out for prepaid cards. Prepaid cards don’t report to the credit bureaus, so they can’t help you build your credit. Think of prepaid cards as a convenience or privacy tool, whereas secured credit cards function as a credit-building tool.
Similarly, debit cards look like credit cards. However, you can’t build credit with a debit card because you aren’t borrowing. Instead, the card provides a convenient way to access money you already have.
How does a secured credit card work?
A secured credit card uses a deposit as collateral. Many lenders require a deposit equal to the credit line but a larger deposit isn’t unusual. Some lenders require deposits 10% higher than the credit line.
If a lender approves you for a $500 credit line, expect to make a deposit between $500 and $550. Once a lender approves your credit line, a secured card works just like an unsecured card. Purchases you make add to the card balance.
Payments you make reduce the balance. If you don’t pay in full, you’ll pay interest on the carried balance. One difference, however, is that secured cards typically require a fixed payment amount. This payment method differs from unsecured cards.
Secured credit cards target consumers who don’t have established credit and people who need to rebuild their credit. Expect credit lines to range between $200 and $500 for most secured cards.
Lower credit lines reduce risk for the borrower as well, so a low credit limit isn’t always a bad thing. However, lower credit limits might force you to plan carefully because you don’t have as much flexibility.
A handful of lenders offer higher limits. If you handle credit responsibly, you may qualify for a higher credit limit. Your credit card company holds the deposit in an FDIC insured account that pays a small yield. Don’t expect to get rich from the interest, but your deposit is safe because it’s federally insured.
How to use a secured credit card to build or rebuild your credit score
A secured credit card works just like an unsecured credit card in most ways, which makes a secured card a great tool for building credit or giving damaged credit a needed boost.
Build your credit with a secured card
Starting your credit journey can be a difficult process. Some people start with department store credit cards because they are often easier to get than major credit cards. Others ask someone else to add them to an account, such as a parent’s credit card account.
These solutions aren’t always ideal. Store credit cards limit your purchases to one location. If you become an authorized user on someone else’s card, you share credit performance with that person, which can be risky for both people.
A secured card bypasses these potential pitfalls by offering wide acceptance and a credit history that’s entirely your own. The industry continues to evolve. Secured credit cards aren’t just utilitarian accounts with no perks.
Rewards cards and cash-back cards now round out the selection and many cards have no annual fee. However, you’ll find higher interest rates with some secured cards and many cards have an annual fee, so it pays to shop around.
Even if you have no credit, if you have some money saved for a deposit, you can start building your credit with a secured card. To build your credit, try to stay well below the limit each month and be sure to pay on time.
You’ll have the most success with your new credit if you treat your credit line as a more convenient alternative to cash. What this means is that you only make purchases you can afford to buy with cash.
Using this strategy ensures you’ll have enough money to pay off your balance in full. With healthy credit habits, you’re on the road to building a strong credit score. As time passes and your score reflects your responsible use of credit, you’ll get pre-approved offers or you can apply for other cards as needed.
Rebuild your credit with a secured card
Life happens. Even with the best of intentions, it’s possible to miss a payment or two and damage your credit score. Sometimes, the damage can be more dire, making it difficult or impossible to get approved for credit.
A secured credit card becomes a valuable tool in these cases as well. If you have bad credit and can’t get approved for a credit card, consider a secured card. Secured cards require a deposit, so you may have to use some of your savings or start saving toward the deposit.
Most cards require $200 to $300 as a minimum deposit, although some have lower deposit requirements. Secured card issuers report to the 3 major credit bureaus, so your responsible use of credit with your secured card pays dividends as your credit score improves over time.
Most negative items stay on your credit report for about 7 years, but your credit score is a big-picture view of your credit behavior. As you add more positive behavior, your score improves, reducing the overall effect of the negative items.
In time, your improved score will earn better rates for credit and may even reduce the cost of other expenses, like insurance. The overall savings are worth the effort.
Advantages of a secured credit card
Secured credit cards bring some advantages over other methods of building or rebuilding credit.
- They accept bad credit: Secured cards are available for low credit scores.
- Convenience: In today’s world, it’s difficult to function without a credit card, especially if you need to make online purchases. A secured card provides a safe way to pay.
- Chance to improve your credit score: Secured card issuers report your credit activity to major credit bureaus. Your on-time payments can translate into improved credit scores over time. If you’re just starting your credit journey, a secured card offers a solid first step.
Disadvantages of a secured credit card
A secured card may not be for everyone. Fees are common and interest rates can be on the high side. Here are some things to consider before applying.
- Annual fees: Many secured cards charge an annual fee of up to $49 per year. However, if you shop around, you can often find a card with a lower annual fee or no fee at all.
- Bankruptcies can hurt your chances: Secured credit card providers check your credit and some credit events can affect your approval. Again, if you shop around, you can often find another provider that will forgive your credit mishaps. Expect card expenses to be higher in this situation.
- Low credit limits: Many cards start out with low credit limits. Think of your starting limit as a stepping stone.
- Your security deposit is off limits: Your deposit is collateral for the credit line. You won’t be able to access the cash, but you may have credit available instead.
How to upgrade to an unsecured credit card?
When it’s time to move on from a secured card, it’s best to apply for a new card before closing the unsecured card. Look at your credit report as well before making any moves.
You’re entitled to a free copy of your credit report from each of the 3 bureaus once per year. If your score has improved, you may be eligible for better rates and a higher credit line with no deposit.
Once you’re approved for an unsecured card, you can close the secured card if you wish. Expect your credit score to drop temporarily because of the new credit inquiry and the closed account which reduces your age of credit.
What are the best unsecured credit card type choices when you upgrade?
Best is a subjective term, but here are some popular choices when it’s time to upgrade.
- Rewards cards: With a rewards card, you earn rewards for making purchases. Many times, these are purchases you would have made anyway. Money you spend earns points you can redeem for merchandise in a catalog.
- Cash-back cards: A cash-back card lets you turn the tables and get paid from your credit card company. You can redeem your cash-back rewards in several ways, including applying the money to your card balance.
- Travel cards: Like other rewards cards, travel cards earn points that you can redeem but the points are for travel.
- Low interest cards: If keeping track of points aren’t your thing, it’s hard to go wrong with a low-interest card. Rewards programs often come with higher rates or annual fees. Sometimes, less is more, especially if it means you’re paying less in fees and interest.
Common Q&A about secured credit cards:
How long does it take to build credit with a secured credit card?
Small changes to your credit score may show in as little as a month or two with a secured credit card. The initial benefit is likely to come from your credit utilization score.
Lenders look at the total amount of revolving credit you have available compared to the amount you’ve used. If you keep the balance low on the new card, your credit score should improve.
Payment history takes slightly longer to affect your credit score. Lenders may also run a credit check before issuing the card. Expect a temporary drop in your credit score because of the inquiry.
Do secured cards issuers report to all 3 major credit bureaus?
A secured credit card functions just like an unsecured card in many ways. Lenders report your activity to the major credit bureaus, including your payment history, credit line, and the percentage of credit you’ve used.
Because issuers report your activity with a secured card to Experian, Equifax, and TransUnion, a secured card offers a great way to build or rebuild your credit score.
What is my credit limit on a secured credit card?
The credit limit for your secured card equals the deposit you’ve made in most cases. Some lenders require a larger deposit, however.
For example, a lender might require a $550 deposit for a $500 credit line. In other cases, a $500 deposit secures the credit line.
Can I increase my credit limit on a secured credit card?
Lenders offer 2 ways to increase your limit on a secured credit card. Some lenders offer a higher limit with a larger deposit.
You usually won’t be eligible for a higher limit right away, however. Expect to wait about 6 months in many cases before you’ll be eligible. Some lenders also offer a credit line increase based on your payment history.
If you make your payments on time, they may reward you with a larger credit limit, without making an additional deposit.
Can I rent a car with a secured credit card?
Yes, you can rent a car with a secured credit card. One thing to consider, though, is whether your credit limit is large enough for the rental charges.
Car rental companies often put a hold on funds for incidental charges, mileage overages, and other expenses.
If the rental cost is $50 per day and you’re renting the car for 2 days, assume the rental car company has a hold on the card for more than $100.
Rental companies release the hold if there are no additional charges but this can take some time and ties up your credit line in the interim.
Can you be denied for a secured credit card?
Secured card issuers sometimes deny credit based on bankruptcies, missed payments, or collections. Insufficient income is another common reason lenders deny secured credit cards.
Even though your deposit secures your credit line, some lenders may say no. If you’re denied for a secured credit card, consider applying with a local bank or credit union, especially if you have a good banking relationship there.
Do secured credit cards hurt your credit score?
A secured card affects your score in the same ways as an unsecured credit card. Payment history plays the biggest role, so it’s important to pay on time. Secured cards can have a larger effect on your credit utilization, however.
Because secured cards often have lower credit lines, your credit utilization can be higher with a secured card. Credit utilization measures your balance against your credit line.
Does applying for a secured credit card count as a hard inquiry?
Yes, credit card issuers run a credit check when you apply. Because the credit check is a request for credit, the pull is a hard inquiry. Expect a short-term ding in your credit score from any hard pull, but the effects are usually short-lived.
Is it okay to close a secured credit card?
It’s fine to close a secured card but there are some things to consider first. When you close the card, the issuer refunds the deposit minus any fees or unpaid balances that may apply.
Closing any credit line, including secured lines, reduces the average age of your credit accounts. If you’re building your credit from scratch, consider the potential effect on your score before closing a credit account.
Do you get your money back when you close a secured credit card?
Yes, the issuer refunds the deposit when you close a secured credit line. The process takes some time, and the issuer deducts any amounts you still owe.
A secured credit card helps build credit or repair credit, but secured cards aren’t a solution in every case and they aren’t a solution that lasts forever.
Think of a secured card as a way to reach a goal. Whether you’re just starting out in the credit world or you have some history and perhaps a few scars, a secured card provides a reliable way to improve your credit.