They start with a security deposit, and, when done right, end with you getting improved credit
Call it the credit card for people with no credit.
A secured card operates much like a regular credit card, except the cardholder makes a security deposit to open the account. Often equal to the credit line, that money assures the card issuer that a borrower won’t rack up a bill and walk away.
But there are plenty of myths and misconceptions about secured cards, too. If you’re considering one, here are nine things you should know.
1. Getting a secured card isn’t a slam-dunk.
You “secure” these cards with a deposit that’s often equal to the credit line. Essentially, you’re giving the lender — in advance — the money that you could walk away owing them. So you might think anyone could get one. Not so.
Even with secured cards, there are some financial sins that will keep you from getting approved. That list can be different for every lender, says Nessa Feddis, senior vice president of the American Bankers Association.
For example, some issuers will decline an applicant who’s had a bankruptcy, while another might welcome them, says Kevin Weeks, president of the Financial Counseling Association of America.
2. Many issuers will pull your credit history.
You’re considering a credit card that’s designed specifically for people with no credit or tarnished credit. But if you apply, a good number of issuers will still pull your credit history, causing a hard inquiry that will temporarily shave a few points off
What gives? Some creditors will pull the credit report to see if you have “any outrageous issues” that might make you a bad risk, even for a card with a security deposit, says Weeks.
3. Anyone viewing your credit report will know it’s a secured card.
When you use your secured card, it looks and operates like a regular credit card. Retailers, hotels, restaurants and nosy friends won’t know the difference. The only possible tell: If it carries the logo of a lender known for issuing secured cards, says Ruth Susswein, deputy director of national priorities for Consumer Action.
But if someone views your credit report, they’ll likely know it is a secured account, says Norm Magnuson, vice president of public affairs for the Consumer Data Industry Association, a trade group for credit bureaus and reporting agencies. That’s because the issuer often codes that into the information it reports to the credit bureaus, he says.
However, when it comes to your FICO score, it doesn’t make a difference whether the card you carry is secured or unsecured, says Can Arkali, a principal scientist with FICO. It’s your behavior, not the type of card you have, that counts when your score is tabulated, he adds.
The flip side: Secured cards often have smaller credit lines than traditional credit cards. Credit scoring formulas reward consumers who use a smaller percentage of their credit line. That “utilization ratio” is about 30 percent of a consumer’s FICO score.
So if you’re trying to grow your credit score, it’s smart to use only a relatively low portion of that credit line, Arkali says, and pay those balances in full every month. If you must make a big purchase that eats up a large percentage of your available credit, consider paying it off immediately, before it can show up on your credit report.
4. That deposit isn’t your cushion.
Even though you made an initial deposit, that doesn’t go toward any of your credit card purchases. The card issuer keeps that security deposit in a separate account for as long as you have the secured card. You should get it back when you close the account, or when you convert it to a traditional credit card, says Weeks. Check the contract before you sign to learn how to claim the money and the expected time frame.
If you have an overdue balance when the account is closed, the lender can deduct it from your deposit. And if that deposit isn’t enough to cover the bill, the lender can come after you for the remainder, says Feddis. If the deposit is more than what you owe, the lender should return the rest, she says.
Remember, though, the reason to have a secured card is to build good credit. Since about 35 percent of your score is determined by whether you pay on time, you need to pay on time, every time.
5. Secured cards are covered by the Credit CARD Act.
Secured cards may differ from traditional credit cards in several respects, but cardholders get all of the same consumer protections, plus some extra ones. That means bills have to be due on the same date every month, and lenders can’t assess multiple fees for the same infraction.
Some other goodies, courtesy of the Credit CARD Act: Upfront fees (which are separate from the security deposit), aren’t supposed to exceed 25 percent of the credit line.
Lenders aren’t allowed to raise rates on new transactions within the first year. And they can’t raise the APR on existing transactions unless the card has a variable rate, the teaser rate expires, or you miss two payments in a row. Even then, if the lender wants to change card terms, it has to give you 45 days’ notice in writing.
Also important: Late fees are capped. Get one every six months, and the lender can’t charge more than $25. Pay late more frequently, and it can charge more.
6. It’s vital to shop fees.
“Look at upfront fees and annual fees,” says Feddis. Find out if the issuer puts those fees on the first bill or subtracts them from the security deposit, she says. Try for one that does the latter.
If the fees are assessed after the account is opened, the CARD Act limits fees to 25 percent (or less) of your credit line. Since the law’s passage, some secured cards slipped around that limit by charging fees before the account is opened, which Linda Sherry, director of national priorities for Consumer Action, finds offensive. “No card should be charging application or processing fees,” she says.
In addition, “you really want to look at annual fees,” Feddis says. “That’s critical.”
7. Some cards make it easier to get an unsecured card later.
“Some people think that a secured card will automatically morph into an unsecured card,” says Weeks. That’s true for some cards, but not for others, he says.
With some cards, the transition can be automatic after a certain time period, others will require you to reapply, he says. And with some secured cards, when you finally want an unsecured card, you’re on your own. So before you even apply, ask about “graduation” to an unsecured card, says Susswein.
“Take advantage of a secured card to get away from a secured card,” says Weeks.
8. Rates are likely higher.
The price you often pay for bad credit? Higher interest rates. And that’s true even with a lot of secured cards, says Weeks.
The solution: “Pay that credit card in full every month so you’re not paying that interest,” he says. Added bonus: That also helps you build good credit, which should be your goal in the first place, Weeks says.
9. Not every card issuer reports to the credit bureaus.
You’re thinking of getting a card to build or rebuild your credit. That means you need your issuer to report that regular good behavior to the credit bureaus (the repositories of your credit history).
But not all secured card issuers report to the bureaus, says Magnuson. Some will report monthly to one or two agencies, but not all three (Equifax, Experian and TransUnion). Others may report every few months, instead of every month, while some don’t report at all. And some card issuers could report only delinquencies or defaults, not your good behavior.
If the issuer doesn’t regularly report good behavior to the credit bureaus, it’s not helping your credit. When you’re shopping cards, ask how often, to which bureaus, and under what circumstances issuers will report your account information. The optimum to build credit: An issuer that reports all account information to all three bureaus every month.