Qualifying for a credit card can be a challenge if you have damaged credit or a short history of using credit. But there is an option if you can’t qualify for a traditional credit card: secured credit cards. Read on to learn about how they can help you build credit.
Qualifying for a credit card can be a challenge if you have damaged credit. It can be difficult, too, if you have a short history of using credit or you haven’t established any credit history at all.
But there is an option if you can’t qualify for a traditional credit card: secured credit cards. These cards, which typically come with lower credit limits and few frills, can help you quickly build a credit history or steadily repair bad credit.
Amy Maliga, a financial educator at Take Charge America, a nonprofit credit counseling and debt management agency based in Phoenix, said secured cards are one of the most important tools for consumers who need to build or rebuild their credit.
“Secured credit cards can be a lifeline for consumers who may have a hard time obtaining credit through other channels,” Maliga said.
But what are secured cards, and how do they compare to unsecured credit cards?
How do secured credit cards work?
There are some important similarities between unsecured and secured credit cards: You can use both types of credit cards to make purchases. You pay back these purchases each month. And if you don’t pay off everything you owe by your due date, you’ll be charged interest on your unpaid balance.
But there’s one big difference between secured and unsecured credit cards, and it has to do with your credit limit.
With a secured credit card, you first make a deposit with the bank or financial institution issuing the card. That deposit becomes your credit limit. If you deposit $500, you can charge up to $500 on your secured card. If you deposit $1,000, your card’s credit limit is $1,000.
Traditional credit cards – which are also known as unsecured cards – don’t require any deposit from borrowers. These are the cards you are probably most familiar with. They’re the standard Visa, American Express, Discover and Mastercard credit cards issued by banks and credit unions.
Your past credit history determines your credit limit on an unsecured credit card. If you have a history of paying your bills on time and a strong credit score, your credit limit will be higher.
The pros of secured credit cards
There are several benefits to secured credit cards for consumers with weak or bad credit.
They’re easier to get
The deposit arrangement is what makes secured cards attractive to borrowers with little or bad credit. If you fail to make your card payments on time, the bank or financial institution issuing your card can take what it is owed from your deposit. Because you can’t charge more than you deposited, you can never owe more than your bank can take.
This offers financial protection to banks and makes it less risky for them to pass out secured credit cards to consumers with a short credit history, or ones with blemishes on their credit reports. It’s easier, then, for consumers to qualify for secured cards than it is for them to nab unsecured credit cards.
“Think of the monetary deposit with a secured credit card like the deposit for a rented property,” said Jim Pendergast, senior vice president of AltLINE Sobanco, a company partnered with Alabama’s Southern Bank Company. “It acts as an assurance that you’ll pay your balances. Just like for a renter’s deposit, you can earn your deposit back by using the card responsibly.”
To qualify for a traditional credit card, especially one with a strong rewards program and a lower interest rate, you’ll need a stronger credit score. With a secured card, though, your credit score isn’t as important because of that initial deposit.
You can use them to build better credit
Every time you make an on-time payment on your secured credit card, it is reported to the three national credit bureaus – Experian, Equifax and TransUnion. As these payments are recorded, your credit score will gradually build if you haven’t had enough credit to generate one, or will slowly improve if you have a score damaged by late or missed payments.
Once your credit score improves, you can then apply for a traditional credit card. At first, you might qualify only for basic credit cards with no rewards programs. But if you make your payments on these cards on time each month, too, your credit score will continue to improve until you can qualify for cards that offer cash back bonuses, miles or rewards points.
The cons of secured credit cards
Secured credit cards also have their drawbacks.
Limited spending power
Your credit limit will usually be lower if you’re using a secured card. That’s because this limit is typically based on your deposit. If your deposit is a low one – say $300 – your credit limit will be low, too.
Secured cards rarely come with rewards programs. You typically won’t qualify for cash back bonuses or free miles when using a secured card.
How long before a secured card becomes an unsecured one?
The good news? You can transition from a secured credit card to a traditional card if you make your payments on time each month. Doing this will boost your credit score over time. And soon, you’ll have a strong enough credit score to ditch your secured card and apply for an unsecured credit card. The provider that issued your unsecured card might even upgrade you automatically after, say, six months to a year of on-time payments with your secured credit card.
Wendy Terrill, a retirement counselor in Burlington, North Carolina, understands this. She had cancer in 1999, and the financial struggles brought about by this caused her FICO credit score to fall below 400. Terrill rebuilt her credit by taking out a secured card, putting down a security deposit of $200. She used that $200 of credit to slowly rebuild her credit score, making small purchases and paying them off on time.
In fewer than six months, Terrill had improved her score enough to qualify for a traditional unsecured card.
“Some don’t understand why you’d pay someone $200 to get $200 of credit,” Terrill said. “You want to build your credit, that’s why.”
Secured cards are an easy and accessible way to rebuild or start building your credit – and, in some cases, earn cash back along the way. Use them diligently, making sure to pay them in full, and in a few months, your credit will be strong enough to qualify for an unsecured credit card.