For consumers with poor credit or no credit history, obtaining an unsecured credit card can be challenging. Many issuing institutions will reject their applications, and those that accept may charge high fees. Secured credit cards solve this problem by requiring a deposit.
A security deposit is an amount you pay upfront to the credit card issuer when you open a secured credit card account. This deposit typically matches your credit limit. For example, if you pay a 200𝑑𝑒𝑝𝑜𝑠𝑖𝑡,𝑦𝑜𝑢𝑟𝑐𝑟𝑒𝑑𝑖𝑡𝑙𝑖𝑚𝑖𝑡𝑤𝑖𝑙𝑙𝑏𝑒200 (minus any upfront fees charged by the issuer). This deposit protects the credit card company if you fail to pay your bill.
Pros and Cons of Secured Credit Cards
Secured credit cards come with various advantages and disadvantages. The following list of pros and cons can help you decide which one suits you.
Benefits
- Building or Repairing Credit: Secured credit cards can help you build or repair your credit score. Regular, timely payments demonstrate that you can manage credit responsibly. Most secured credit cards report your payment history to the three major credit bureaus. Positive information can boost your credit score over time. A higher credit score can help you qualify for better financial products in the future, including credit cards and loans.
- Learning Financial Discipline: Secured credit cards can teach you financial discipline. Since you must pay a security deposit, you’ll be more mindful of your spending. You’ll learn to track your purchases and stay within your credit limit, and paying your bill in full each month can help you avoid interest charges and debt. These habits are essential for managing any credit card.
- Available to Individuals with Poor or No Credit: Consumers with poor or no credit can obtain secured credit cards. Since the deposit reduces the issuer’s risk, it’s more likely your application will be approved. If creditors have denied your other types of credit, secured credit cards are a practical option. You can use secured credit cards to start building or repairing your credit history without worrying about your past financial challenges.
- Transition to Unsecured Credit Cards: Responsible use of secured credit cards can qualify you for unsecured credit cards. Many issuers periodically review your account. If they notice a good payment record and an improved credit score, they may offer you an unsecured credit card upgrade. This means you won’t need to deposit more money and may receive a higher credit limit.
- Establishing a Relationship with Banks: Secured credit cards can help you build a relationship with issuers, banks, or credit unions. In the long run, this is beneficial for your financial situation. Establishing a good relationship with a bank can make it easier for you to get approval for loans, better credit cards, and other financial products.
- Lower Costs: For users with poor credit, many secured credit cards have APRs and fees lower than unsecured credit cards. For example, secured credit cards never charge monthly maintenance fees or registration fees. Unsecured credit cards for users with poor credit are notorious for charging these fees. Additionally, the APR for secured credit cards rarely exceeds 30%, while some unsecured credit cards have APRs as high as 36%.
Disadvantages
- Prepaid Deposit: Secured credit cards require a prepaid deposit. This can be a drawback if you don’t have money to put aside. The refundable deposit typically equals your credit limit, so a higher credit limit means a larger deposit. Some secured credit cards also charge annual fees. Considering these costs before applying is crucial.
- Limited Credit Limit: At least initially, the credit limit for secured credit cards may be lower. Your credit limit typically equals your security deposit amount. This determines your purchasing power. If you need a higher credit limit, you must increase your deposit. Limited credit limits also affect your credit utilization ratio, the ratio of used credit to total credit available. Keeping this ratio low (i.e., below 30%) is crucial for achieving a good credit score.
- Risk of Losing Deposit: You may lose your deposit if you fail to pay your credit card bill. If you fail to make timely payments, the issuer may use your deposit to pay off the debt. This means you may not be able to recover part or all of your deposit. Additionally, failing to make timely payments can damage your credit score. Only apply for a secured (or unsecured) credit card if you can make timely payments.
How to Choose a Secured Credit Card
Choosing a secured card is easiest if you compare available products side by side. Let’s see what to look for:
Compare Interest Rates and Fees
When comparing secured credit cards, look at interest rates and fees. The interest rate or APR is the cost of borrowing money on the credit card. Lower rates mean you’ll pay less in fees if you carry a balance (which you should avoid if possible).
Additional fees may include annual fees and late payment fees. Some credit cards may waive the annual fee entirely or suspend it for the first year. Be sure to read the terms and conditions to understand all potential fees.
Check Minimum and Maximum Deposit Requirements
Different issuing institutions have varying deposit requirements. Some cards require a minimum deposit of $200, while others may allow you to deposit more money for a higher credit limit.
The minimum deposit is the lowest amount you pay at account opening. The maximum deposit is the highest amount you can deposit (in some cases, $5,000 or more).
Consider how much deposit you can afford. A higher deposit will give you a higher credit limit, which can help you spend more money or improve your credit utilization ratio.
Evaluate Additional Benefits or Rewards
Some secured credit cards offer additional benefits or rewards, such as cashback, points, and travel benefits. Look for credit cards that reward you for purchases you make most often.
Other benefits may include fraud protection, free credit score monitoring, or rental car insurance. Compare the benefits of different cards to see which ones meet your needs. It makes more sense to choose a card with good benefits.
Security Deposits Lower the Risk for Credit Card Issuers
Security deposits act as a financial safety net, helping credit card issuers. They allow issuers to offer credit to individuals with poor or no credit, which can help cardholders build or repair their credit history. By lowering the issuers’ risk, security deposits provide a more equitable path to credit.
Secured credit cards are a sensible first step toward a better financial future. Simply make payments on time and keep a low balance. Whether you’re a credit novice or recovering from bankruptcy, responsibly using a secured card can improve your credit score and financial outlook.