If you use it properly, a secured credit card is a great way to build your credit history and improve your credit score. That being said, you do have to be careful here like with any other credit card.
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.
But what are secured cards, and how do they compare to unsecured credit cards? Keep reading to find out.
What is a secured credit card?
For the most part, you can use a secured credit card in the same way as a traditional unsecured credit card. The main difference is that with a secured credit card you put down a refundable security deposit that acts as your credit limit and you can’t spend more than amount. Essentially, you aren’t really borrowing money, because if you can’t pay what you owe, the credit card issuer will use your deposit to pay off the balance.
Secured vs. unsecured credit cards
Here’s a quick overview of how these two types of credit cards differ:
Secured credit cards
- Must make a security deposit (refunded when you close the account in good standing)
- Security deposit acts as your credit limit
- Fail to pay and card issuer uses your deposit for payment
- Easier to qualify for if you have bad credit, since issuer risk is low
- APR often higher than an unsecured credit card’s
Unsecured credit cards
- Credit score affects interest rate and credit limit
- Hard to qualify with a bad credit score
- APR typically lower than secured credit cards’
- No deposit required — borrow money from the credit card issuer to make purchases
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. On-time payments with each type of card help your credit score and late payments hurt it.
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 it. 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. 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 and cons of secured credit cards
There are some notable benefits and drawbacks to secured credit cards for consumers with bad or nonexistent credit:
- Better approval odds. With a secured card, your credit score isn’t as important as with a traditional card because you’ve put up collateral with your initial deposit. 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. Since this reduces much of the risk for issuers, secured cards are much easier to get approved for with poor, little or no credit.
- Lower risk of overspending and new debt. You can’t charge more than you deposited, so your debt won’t be able to spiral beyond what you can ultimately pay off.
- Great tool 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.
- 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.
- No rewards or perks. Secured cards rarely come with rewards programs. You typically won’t qualify for cash back bonuses or free miles when using a secured card.
Tips for using a secured credit card
Here’s a few ways you can get the most out of a secured credit card.
To start, you should only spend what you can afford to pay off right away, that way you can always afford to pay your bill each month and can work toward improving your credit score. Late payments will harm your credit score.
Another good reason to avoid making too many charges is so you can keep your credit utilization ratio nice and low. Having your credit utilization ratio below 30 percent helps boost your credit score. Paying your balance in full each month can help accomplish this.
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 consistently 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.
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 and make sure to pay them in full and your credit may be strong enough to qualify for an unsecured credit card in a matter of months.