One of the biggest things that a credit card company looks at when approving a credit card application is the applicant’s credit history. For those who have poor credit or limited credit history, it can be hard to get approved.
The good news is that even if you are denied a traditional credit card, you still have options thanks to secured credit cards. These cards, which operate a little differently than the unsecured credit cards that you’re probably familiar with, can help those who would otherwise not qualify for credit.
In this article, we’ll discuss secured credit cards, how they are different from unsecured cards, and how you can benefit.
What is a secured credit card?
A secured credit card is a type of credit card that is backed by a cash deposit. This deposit is made by the cardholder whenever the account is opened. If the cardholder is unable to make monthly payments, the initial deposit serves as collateral and the credit card company can easily recoup their money.
Secured vs. Unsecured Credit Cards
In general, there are two types of credit and loans: secured and unsecured.
Secured loans and lines of credit are those that are backed by collateral. For instance, a home mortgage is backed by a house and an auto loan is backed by a vehicle. If a borrower defaults on one of these loans, the bank will seize that piece of property. While this benefits lending institutions, it also helps diligent borrowers. Because a bank assumes less risk, they offer better loan terms and more lenient application standards.
With unsecured loans and lines of credit, such as most personal loans and traditional credit cards, financial institutions assume more risk. To mitigate this risk, lenders will have stricter approval standards and often charge a higher interest rate.
How does a secured credit card work?
In many ways, a secured credit card operates like a traditional unsecured credit card. They are accepted anywhere regular credit cards are accepted and function identically when you purchase something. At the end of the billing cycle, you’ll receive a statement that shows your balance and the minimum amount due. Should you choose to pay only the minimum rather than the full balance due, the remaining balance will be subject to interest charges.
There are two main differences between a secured and an unsecured card. For one, your limit with a secured card is set by your deposit amount. So, for example, if you put down a $300 deposit, your credit limit will be $300. If you charge that amount to the card, you will not be able to use it until you’ve paid down your balance. Secondly, if you fail to pay off your balance, the card issuer will use your deposit to recoup their losses.
Who is a secured credit card best for?
Anyone can open a secured credit card, but for those with poor credit or a short credit history, the card can be especially beneficial.
It can be easy to get trapped in a cycle of credit denial. Lenders and credit card companies won’t extend credit to those with poor or no credit, but it’s hard to establish or build your history without having some type of credit card or loan.
A secured credit card allows you to break this cycle. Because there’s an easy and guaranteed way for banks to get their money back if you are unable to make payments, pretty much anyone can qualify for a secured card.
A secured credit card can be handy in and of itself, but what is especially beneficial is the opportunity to establish or build your credit so that you can take advantage of other credit cards down the line. It’s a starting point for those without an existing credit history and a lifeline for those who are rebuilding their credit score.
Pros and Cons of a Secured Credit Card
Here’s how all of this breaks down in terms of advantages and disadvantages.
It’s easier to get approved. Even if you’ve been denied for other cards, you will likely be approved for a secured card.
They require an upfront deposit. It’s not always easy to get together a few hundred dollars for the deposit. Keep in mind that deposit amounts range. Some cards may require a deposit of several thousand dollars while others may have a minimum deposit of $200. Remember that this number will also be your credit limit.
Secured credit cards can help establish or build your credit history. If you are looking to raise your credit score to be eligible for other credit cards in the future, a secured card is a great place to start. If you use it wisely, it can help you raise your credit score.
There may be more fees involved compared to other credit cards. Depending on what card you get, you may face more fees compared to an unsecured card. Shopping around for a card with fewer fees can help you avoid this.
You can get your deposit back when you close the account. As long as you keep your balance paid off, you will receive your deposit back whenever you are ready to close the account.
You will still have to pay interest charges if you don’t pay off your total balance. Don’t think that a secured credit card is your ticket to spend without the possibility of accumulating debt. If you don’t pay your balance in full every month, you will start racking up interest charges, which can range between 15% and 25%.
If you default, you won’t get sent to collections. If, for whatever reason, you aren’t able to make your payments and you default, you won’t get sent to collections unless the amount owed is greater than your deposit amount. The credit card company will simply keep your deposit. Keep in mind that this is not a free pass to simply not pay your bill— a default can severely impact your credit score.
You can still get a card with rewards. Like their unsecured counterparts, some secured cards offer special rewards and perks when you use the card.
Build Your Credit with a Secured Credit Card
A secured credit card can be a great way to establish or build your credit. Because the card is backed by an initial deposit, the credit card company assumes less risk, making it easy for anyone to get approved. Though it may not be as robust as some unsecured credit card offerings, it’s a great steppingstone if you’re unable to get approved for traditional cards.