Having a good credit score is not only crucial for making large purchases for things such as homes, vehicles, and high-end appliances, but it’s also necessary to obtain low-interest loans, employment at specific companies, and some residential renting approvals.
Essentially, secured credit cards offer a way for individuals with unestablished or poor credit scores to use deposited cash as collateral for credit card purchases.
Does this mean that secured credit cards don’t come with certain caveats? Of course not, but if you’re someone who’s run into a low credit score setback, they may be an excellent way for you to get on the road to rebuilding it.
Here are a few of the pros and cons of secured credit cards.
- They offer the opportunity to slowly rebuild your credit score by making timely monthly payments (emphasis on the word “timely”).
- Your credit score will show more credit lines and increase your borrower credit-worthiness in the eyes of lenders.
- Secured credit cards give you the opportunity to set your credit limit, according to your comfort level.
- You can qualify for one even if you have a low credit score and unpaid debts.
- There are a few credit issuers who report secured cards as “secured” instead of just listing them as credit lines. Make sure to ask about reporting before applying.
- Secured credit cards will usually have higher interest rates.
- Unlike unsecured credit cards, secured credit cards require a deposit.
- The amount of your deposit determines the amount of your credit line.
- Some secured credit cards can come with exorbitant fees, which can whittle away the amount you have available to spend.
The bottom line: how getting a secured credit card helps your credit.
Not convinced yet? Here’s the nitty gritty on how getting a secured card will help you. Your credit score is based on 5 things:
- Your payment history (35%)
- Your total use of your credit limits. (30%)
- The length of your credit history (15%)
- The amount of new credit you have (10%)
- The “mix” of your credit. (10%)
We’ll go over how each of these factors can be helped with a secured credit card.
Payment history. Once you receive a new secured credit card, as we’ve mentioned several times in this article, it is important to make your payments on time. As you can see, your payment history is the most important part of your credit score.
Credit utilization. We mentioned that you should keep your balances at 25% of your total limit. With secured cards, your credit limit is going to be quite low compared to unsecured cards, especially if you can’t afford to make large deposits to open an account. Many people have $500 limits to start with. (Just so you know, 25% of $500 is $125.) Some experts say that 10% is the limit you really need to stay under, but you should be ok around 25%. Really, you are using the secured cards to rebuild your credit and they should be looked at as a tool rather than the way an unsecured card is to be used (as a convenience for shopping). You shouldn’t be charging a lot on your secured cards.
Length of credit history. The total length of your credit history will not change when you get a secured card, unless you have no credit history at all. However, the older an account is on your credit report, the better your score (if your payment history and credit utilization are good). Having “seasoned” good credit lines on your credit report will indicate to future lenders that you are now a responsible consumer. There is no time like the present to begin building your credit report.
New credit. The ability to apply for and receive new credit is an indication of your credit worthiness. Getting new credit lines looks good to lenders and is reflected positively on your credit score.
Mix of credit. Lenders like to see that you have both installment (auto CPN loans and mortgages) and revolving (credit cards, equity lines of credit) on your credit report. If you only have installment CPN loans on your credit report, applying for a revolving line of credit (a secured card) will help improve your score. If you have no installment CPN loans (you don’t have a mortgage or auto loan), getting a secured card will help you obtain an auto loan or mortgage in the future.
Helpful Guidelines When Using Secured Cards
Secured credit cards provide a practical way to build purchasing habits that can keep you reined in from impulse or frivolous spending. Ensuring that you use your card wisely is of the utmost importance. Here are some ways to do this.
- Make EVERY payment on time. That may seem like a no-brainer, but it’s important to emphasize. After all, this is the foundation of building good credit: paying back what you owe. If you can make payments before your due dates, even better. Payments that are 30 days or more past the due date can get listed on your credit report, which means another setback to the improvement of your score.
- Keep your balance at a reasonable level. Try not to make massive purchases on a secured card and aim to keep the balance no more than 25 percent of your limit. You’ll want to want to minimize the amount of debt shown on your credit report while you work to rebuild your credit.
- Use one secured card a time. Establishing several secured credit cards can be a big red flag to issuers. Remember that the more you apply for credit, of any form, the more hits on your credit score, which can have a negative impact. Work on making steady payments on your credit card anywhere from six to eight months before applying for new credit lines.
- Ask about reporting. Find a card that reports to all three of the major credit bureaus, so that your credit history will be consistent for each bureau.
- Set up a monthly autopay. Many issuers offer an autopay option to make payments easier for cardholders. If your card doesn’t provide this, consider setting it up through your banking institution. Auto-payments help you to avoid late payments and may even make you eligible for specific discounts.
- Go with established card issuers. Apply for secured credit cards with well-known, reputable credit institutions and be leery of unestablished card issuers.
Breaking Down Secured Credit Card Fees
It’s important to understand the fees associated with your card before accepting the terms. If you’re looking to rebuild your credit, the last thing that you need is a new credit card with month-to-month fees that you can’t afford to pay.
- Application Fees — Some issuers charge an initial fee to apply for a secured credit card, which can be upwards of $50. While most do not, you should always read the application terms before signing up.
- Annual Fees — Annual fees are deducted from your deposit every year, though the best-secured cards will come with no or low annual fees.
- Interest Rates — Also referred to as APRs, these fees get deducted from your deposit on a yearly basis, and the percentage amount will vary with each card issuer. While secured cards typically have higher APRs, it’s always best to shop for the best deals. APR stands for annual percentage rate and is a calculation that is based on the total cost of owning the card.
- Transaction Fees — Some secured cards come with a small fee attached to every purchase you make, and this small fee can quickly add up to a significant cost at the end of your billing cycle. Remember that the small purchases count, too.
How to Find the Right Secured Credit Card for You
Spend some time checking out the numerous card options that may be available to you, because it’s worth it. Here are a few takeaways that you’ll want to use when making your decision.
Is the company reputable?
Be wary of unknown or new card-issuing companies. Unfortunately, the financial industry is fraught with scammers and sub-par lenders who thrive on taking advantage of unsuspecting borrowers. Check online reviews, the company’s history (and time in business), Better Business Bureau feedback, and any other sources where you can gather information about their lending practices.
What deposit is required?
Similar to vehicle purchases, the amount of your deposit will go towards your card balance, but remember that your deposit will determine your limit. It can be as low as $200 or as high as $9,000.
What interest rates (APR) and fees come with it?
Have a clear understanding of all fees associated with opening and maintaining your account. Saying it’s important to “read the fine print” when it comes to applying for credit cards, secured or not, is an understatement. Trying making a list of at least 10 top card picks and compare their rates to see which offers the best benefits for you.
How do they report your credit? Is it to all three Major Bureaus?
Inquire about your potential cardholder’s reporting details. Remember, it’s essential to choose an issuer that not only reports to all three credit bureaus (Experian, Trans Union, and Equifax), but also reports secured cards simply as “credit” and not “secured credit.”
Applying for a Secured Credit Card
You can apply for a secured credit card online or at your banking institution or credit union. When you do, you should be ready to supply the following documentation:
- Name, contact details, and social security number (must be 18 years or older, of course)
- All income documentation and verifiable employment details
- Bank or credit union details including history, balance, date opened, and additional account holders
Secured credit cards can be the answer to rebuilding your credit if used in the right way. Make sure to keep a close eye on your credit reports from all three bureaus to ensure consistency and inaccuracy as you work to build your credit scores. And while rebuilding your credit isn’t an overnight process, it’s one that is worth the effort.