Secured credit cards offer borrowers access to a line of credit, even if those borrowers don’t have good credit histories. Here’s how they work.
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Trying to borrow money without a good credit history can leave consumers caught in a vicious circle: Good credit is often required to get approved for loans, but good credit can only be achieved by having — and using — credit responsibly over time.
Enter secured credit cards. These card products offer borrowers access to a line of credit, even if those borrowers don’t have good credit histories. Lenders are willing to extend credit to such borrowers because the credit line is “secured” by a cash deposit (provided by the consumer) that guarantees the bank gets repaid even if the cardholder runs into trouble. As a result, secured cards can provide credit to borrowers who may have been denied for loans in the past, while simulatneously helping them build a credit history so that they can get approved for unsecured credit in the future.
Consumer advocates say these products can be a helpful tool for certain borrowers. “Secured cards are a good choice for those who have trouble opening traditional lines of credit,” says Gail Cunningham, vice president of public relations for the National Foundation for Credit Counseling. “Examples of people who are a good fit for a secured card are those who are establishing credit for the first time or are attempting to rebuild their credit,” she says.
Borrowers can make payments using secured cards just as they would with traditional unsecured credit cards. To be sure they will build a credit history, however, borrowers should check that their secured card issuer reports all borrowing activity to the credit bureaus. Otherwise, the card’s use and repayment won’t help the cardholder establish credit.
If the secured card does get reported, borrowers can build a positive credit history by using the plastic carefully. That makes secured cards an attractive choice. “The benefits are that you have the convenience of a credit card and can construct a positive credit file if you handle your obligations responsibly,” Cunningham says. After a period of time, the issuer may even convert the secured account to an unsecured account with a higher credit limit.
That doesn’t mean consumers who use secured cards don’t face any financial challenges, however. “The downside is that the card may assess fees, and the line of credit will likely be small, as it is limited to the amount of money you use to open the account,” the NFCC’s Cunningham says.
Despite those fees and small credit lines, secured cards offer a way for consumers with bad credit or no credit scores to break the vicious cycle. Therefore, a “secured card is a useful tool for many,” Cunningham says.
See related: 4 ways to re-establish credit after bankruptcy, 5 post-bankruptcy myths, New arrivals to U.S. need to rebuild credit history, Alternative ways for students to build a credit history, Consider these options before co-signing for a card