If you're looking to build your credit, then a secured credit card may be the solution you're looking for.
What A Secured Credit Card Does
A secured credit card is a type of credit card that is secured by collateral. This is an important tool to help you build your credit by establishing a history of on-time payments, as long as your credit card issuer reports these payments to at least one of the three major credit bureaus (Experian, Equifax, and TransUnion).
When To Get A Secured Credit Card
If you have little, no, or bad credit, then you may want to consider a secured credit card to help you build and improve your credit.
How It Works
A secured credit card requires you to put down a security deposit (the card's collateral), which acts as the credit limit and covers you if you miss a payment. This security deposit is generally equal to your credit line. Some lenders will allow you to make an additional security deposit to increase your available credit.
As long as you pay your credit card bill in full, you will be allowed to keep the deposit; however, if you default on the payments, you will lose your collateral.
If you have bad or no credit, qualifying for a credit card or any other line of credit is difficult. Secured cards can help you build positive credit history. Your card issuer will report on-time payments to the bureaus, which will gradually improve your credit.
Secured cards share a lot of the same features as credit cards, such as monthly payments, interest, and fees. And just like a credit card, you should make all your payments on-time and in full while keeping your credit utilization low. The risk of not using your card correctly can cause credit damage and added interest since they typically come with high interest.
Once you've built your credit, secured card issuers may offer a card upgrade (you can request an upgrade as well) that allows you to convert your account to an unsecured account or close your secured card to open a new unsecured account.
Even if you don't qualify for an upgrade, you can close your account eventually and open up an unsecured credit card.
As long as you are using your secured card responsibly, your credit will improve and future lenders will be more likely to extend credit to you. Results vary, but many individuals see improvements anywhere from a few months to a year.
How To Get A Secured Credit Card
Qualifying for a secured credit card is easier than getting a regular credit card, but approval is not guaranteed.
The card issuer usually checks your credit for any signs of extreme risk (bankruptcy, serious delinquency, etc) and requires proof of income to make sure that you can cover your payments, even if your security deposit covers late/missed payments.
You can shop around for cards through online lenders and compare offers and when you've found the best one for you, simply fill out an application and put down a security deposit.
You will be evaluated by your lender through an underwriting process receive your card once approved; if denied, your security deposit will be refunded.
How To Use A Secured Credit Card
To get the best use out of your secured card, you need to take actions that will show future lenders that you are a low-risk borrower:
- Make small purchases that you can afford.
- Pay the full balance off each month in order to avoid interest and build on-time payments.
- Monitor your credit while you continue to use your card responsibly.
Depending on the card issuer, a secured credit card requires a deposit between $200 and $1,000. You can get a card without a security deposit, but you will most likely be charged high processing fees, application fees, and annual fees.
Your credit limit is usually the same as your security deposit.
Unlike a prepaid debit card, a secured credit card does not require you to load money onto the card to use it. Instead, your security deposit works as collateral if you don't make your payments.
Your issuer may allow you to increase your credit limit by depositing more funds or give you a credit limit increase if you use the card responsibly.
Generally, you can get your deposit back when you close your account and if you're in good standing with your issuer.
Some secured cards have an annual fee, which is usually less than $50.
You will usually have to pay interest on your secured card, which are set based on how risky of a borrower you are. Interest rates can go as high as 20%, but as long as you are paying your balance on-time and in full, you shouldn't have to worry about interest.
Secured Credit Card Pros
- It's easier to qualify for a secured card than an unsecured credit card.
- Building positive credit history allows you to receive lower interest rates, lower fees, credit card rewards, and more.
- Some secured credit cards can be upgraded to an unsecured credit card when used responsibly.
- If you fail to make a payment, your security deposit is used as collateral, which means you avoid the risk of your debt being sent to collections. However, you will still have a late payment reported.
- Some secured credit cards allow you to earn a small amount of interest on your security deposit.
Secured Credit Card Cons
- Secured credit cards are made for consumers with bad credit or no credit, so taking one out when you have good credit won't help you much.
- Secured cards can come with application fees, annual fees, and high interest rates.
- Many borrowers with bad or no credit don't have the funds to acquire a down payment for their security deposit -- anywhere from a $200 to $1,000. (Note: Some card issuers allow you to split the deposit into set payments over time.)
- Secured credit cards generally come with low credit limits.
- Not all secured cards allow you to upgrade to an unsecured card after a specific period of time, meaning you'll have to undergo the application process again to get an unsecured credit card.
Alternatives To A Secured Credit Card
If you need a card to make payments but you're on the fence about taking out a secured credit card, you can use these alternatives:
- A prepaid credit card. Many of these cards have well-known logos such as American Express, MasterCard, or Visa. Like a secured credit card, it is loaded with your own funds, but you won't be able to build credit with it.
- Credit-builder loans: A credit-builder loan helps you establish a good payment history. Your borrowed amount is held in a savings account while you repay it in monthly installments. Once it is fully repaid, the funds are released to you and your credit report will show a paid-off loan.
- Personal loans: Regardless of whether you have good credit, bad credit, or something in-between, a personal loan can help you build your credit with a history of on-time payments.
If your main goal is to establish or improve your credit score, then you may want to consider these alternatives:
- Repair your credit: Check your credit report for inaccurate or unverifiable items and dispute inaccuracies on your own or by using a reputable credit repair service. You can obtain a free copy of your credit report once a year at AnnualCreditReport.com.
- Get a credit-builder loan: You can use a credit-builder loan (like the ones from Self Lender) to improve your credit score by borrowing a small amount and paying it back on time.
- Pay your bills on time: Always pay on time since even one late payment can drastically impact your credit.
- Keep your credit utilization low: Avoid high credit utilization and aim to keep your credit utilization below 30%.
- Keep your old accounts open: Even if you have credit accounts that you don’t use, keep them open to establish that you have a longer credit history.
- Monitor your credit: Routinely check your credit through a credit monitoring service.
Do secured credit cards help my credit?
Yes. While the initial hard inquiry may damage your credit slightly, this isn't permanent. As long as your issuing bank reports your activity to the three major credit bureaus (Experian, Equifax, and TransUnion) and you are paying on-time and in full, your credit can improve.
What if I get turned down after applying for a secured credit card?
Although it doesn't happen often, you can be turned down for a secured credit card due to poor credit or any serious negative situations (such as a bankruptcy, foreclosure, or history of late payments).
If this does happen, you can ask the credit card issuer why you were denied. In the case it was due to a credit-based issue, you can obtain a free copy of your credit report and dispute any inaccurate information.
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