There are lots of secured credit cards on the market, but it can be hard to figure out which one is the best. By the end of reading this article you will know all about how these cards work, weather or not you should get one, and tips of using them effectively.
What are Secured Credit Cards
Secured credit cards are a type of credit card that requires you to make a cash deposit (your “security”) into an account with the same bank.
The amount of your security deposit determines how much credit limit you have and how much money you can spend on the card.
The interest rates are usually higher than those on other types of cards, but they’re also lower than some other types of loans—and if you don’t make any late payments, your interest rate will be 0%.
When it comes to benefits and drawbacks, secured cards are similar to many unsecured cards: They can help build up your credit score and provide access to better terms when applying for unsecured cards in the future.
How Do Secured Credit Cards Work?
Deposit and Credit Limit: When you open a secured credit card, you deposit a sum of money into a secured account, which indeed acts as collateral. This deposit usually determines your credit limit, meaning if you deposit $500, your credit limit will typically also be $500.
Usage and Payments: You use a secured credit card much like any other credit card. You can make purchases and pay bills up to your credit limit. Each month, you receive a statement for the purchases made with the card.
Paying the Balance: Contrary to the explanation provided, the bank does not automatically take money from your deposit to pay off the balance each month. It’s the cardholder’s responsibility to make payments towards the balance, just like with an unsecured credit card.
If you fail to make payments, it may result in fees and damage to your credit score, but the deposit is typically not used to cover the payments unless the account is closed or defaults.
Interest Charges: If the balance is not paid in full each month, interest is charged on the remaining balance. The deposit does not shield you from interest charges; it’s only there as security for the issuer in case of default.
Automatic Payments and Refunds: Payments are not automatically taken from your deposit. However, you can often set up automatic payments from a bank account to help manage the balance. If you manage the account well and eventually qualify to upgrade to an unsecured card or close the account in good standing, your deposit is refunded.
What to consider when applying for a secured credit card?
The best secured credit cards in my opinion are those that help you rebuild your credit with minimal costs. Here are some key features to consider:
Low Fees: Seek out secured cards with low annual fees and reasonable interest rates. Unlike some common misconceptions, higher fees do not equate to better benefits with secured cards. The primary goal is to build credit affordably.
Credit Reporting: Ensure the card reports to all three major credit bureaus (Experian, Equifax, and TransUnion). Regular reporting of your credit activity is crucial for building your credit score.
Learn more on how to get your free Credit Report in the US
Upgrade Options: Some secured cards offer pathways to “graduate” to an unsecured card after a period of responsible usage. This feature is valuable as it shows the issuer’s commitment to helping you improve your credit standing.
Reasonable Interest Rates: While secured cards generally have higher interest rates, look for ones that are competitive. Keeping your balance low and paying it off in full each month can help avoid interest charges.
Fraud Protection: Like unsecured cards, secured credit cards should offer strong fraud protection. This means you won’t be held liable for unauthorized transactions, offering peace of mind and security.
Learn more on placing a fraud alert to protect yourself from authorized use of your identity.
Low Deposit Requirements: Some secured cards allow you to open an account with a smaller deposit, which can be helpful if you’re trying to build credit on a budget. The deposit is typically equal to your credit limit and is refundable if you close the account in good standing or transition to an unsecured card.
By focusing on these aspects, you can choose a secured credit card that not only helps rebuild your credit but also minimizes costs and maximizes potential benefits.
Is a secured credit card worth it?
Secured credit cards can indeed be a valuable tool for building or rebuilding credit, but they operate differently from unsecured credit cards. Here’s how they really work:
Deposit and Credit Limit: Unlike unsecured credit cards, secured cards require you to make a deposit which typically becomes your credit limit. For example, if you deposit $1,000, your credit limit will generally be $1,000. This deposit is used as collateral by the credit issuer.
Credit Building: Secured cards are effective for building credit because they report to the major credit bureaus, just like unsecured cards. By using a secured card responsibly—keeping balances low and making payments on time—you can improve your credit score over time.
Related Article: Smart Tips on using a credit card. | How credit cards can improve your credit score
Fund Access: The initial deposit you make for a secured credit card is not a fund that the bank uses or releases based on payment behavior. Rather, this deposit is held as security and is generally only returned when you close the account in good standing or transition to an unsecured card. Your regular payments must come from your own funds, not the deposit.
Costs and Fees: While secured cards can help build credit, they often come with higher interest rates and fees than unsecured cards. It’s important to read the terms carefully and manage the card wisely to avoid excessive costs.
Secured credit cards are worth considering if you have limited or damaged credit and want to improve your credit score. They require a financial commitment in the form of a security deposit but can offer a path to better credit health and eventually qualifying for unsecured credit cards with more favorable terms.
What I would do to use a secured card wisely
To make the most of a secured credit card, consider the following:
Pay Your Bill On Time: Paying your bill on time is crucial for building credit and avoiding late fees. However, paying on time does not affect the interest rate you are charged on a secured credit card, as interest rates are typically fixed when you are approved for the card. The statement that paying on time could lower your interest rate is not accurate for credit cards. Consistent on-time payments can help you qualify for cards with better rates in the future, though.
Manage Spending: It’s essential to spend within your means and avoid carrying a balance, as the interest rates on secured credit cards are often higher than those on unsecured cards. The advice to not spend more than you can afford is sound because carrying a balance will result in paying high-interest charges, which can quickly accumulate.
A budget is telling your money where to go instead of wondering where it went.
Dave Ramsey
Avoid Cash Advances: The advice against using your credit card for cash advances is very wise. Cash advances come with high fees and interest rates, and interest typically starts accruing immediately, unlike purchases, where you might have a grace period. Avoiding cash advances can help keep costs down and prevent the debt from growing.
Additional Tip – Monitor Credit Utilization: Keeping your credit utilization low (generally recommended below 30% of your limit) is another effective way to manage your secured card. This not only helps in building your credit score but also keeps your monthly payments manageable.
Related Article: Tips on how not to be buried in credit card debts
With good credit habits and time, you can build your credit score with a secured card.
If you’re new to credit, it can be difficult to get started. A secured card is one of the best ways to build your credit score. A secured card is more like a debit card than a traditional credit card – you deposit money into an account that acts as collateral for your spending limit on the card.
If you don’t make payments on time, the bank will take that money out of your account and use it to make up what you owe them.
Because these are low-risk options for banks, they tend to offer better interest rates than regular prepaid cards or unsecured credit cards – which makes them an excellent way to build up your financial skills while earning rewards at the same time!
Bottom Line
Secured credit cards are a great way to get started building (or rebuilding) your credit score. By making careful use of the card, you can improve your credit, get approved for more favorable rates on other loans or credit cards, and save yourself a lot of money in the long run.
Just remember to make all payments on time and avoid accumulating too much debt on your card. It’s also important to check your credit score regularly so that you can see improvement over time and feel good about how much progress you’re making!
