What is a Secured Credit Card and Do You Need One?

If you’ve never had a credit card before or have already received that dreaded credit card rejection — don’t worry. There’s still a way for you to build credit. A secured credit card allows you to build a positive credit, even if you have a poor credit score or no history. While other cards rely on your history to determine your creditworthiness, a secured credit score is backed by a cash deposit to ensure your balance will not be lost.

Secured credit cards are good for those who want to build their credit history and get practice using credit wisely. Learn more about secured credit cards below:

What is a Secured Credit Card? 

Though they may function similarly to debit cards, they still are credit cards. When you open one, you usually make a cash deposit that is equal to your credit limit. The minimum deposit is often $200, but can be larger or smaller.

The deposit acts as collateral for your bank in case you were ever to miss a payment. Since the bank won’t lose money in this situation, they can afford to take on riskier users, like those with poor or thin credit history.

How Do Secured Credit Cards Work? 

Though they can be easier to acquire, secured credit cards still require an application. While issuers don’t expect a flawless credit history, will sometimes look for red flags like bankruptcies or a history of missed payments.

Once you’re approved for a secured credit card, you’ll need to secure your account with a deposit. The money you deposit for a secured credit card is refundable once you close or upgrade the account, as long as you’ve made all of your payments on time.

Each month, you’ll only be allowed to spend up to the amount you have deposited. It’s important to understand that secured credit cards are not like prepaid debit cards in that the purchases do not take money from your deposit. In addition, your balance will not be paid from your deposit each month automatically. In order to demonstrate responsible use of your card, you’ll need to make payments each month from another account. While you don’t have to pay off your balance in full, the higher interest rates with secured credit cards mean that it is wise to do so.

The major benefit of secured credit cards is that many card issuers reports monthly to all three credit bureaus. That means that if you consistently make payments and show a responsible use of credit, having a secured credit card may raise your score.

Some banks offer a way to “graduate” from a secured credit card to an unsecured one. This essentially means that after a period of time of using your secured card responsibly (typically around a year or less) you will qualify to change to an unsecured account or open a new unsecured credit line.

Some secured credit cards offer additional benefits like interest on your deposit or cash back rewards. Since the requirements and benefits can vary by each financial institution, be sure to do your research when applying.

Comparing Secured Credit Cards to Other Cards

Secured Credit Cards vs Unsecured Credit Cards

The main differences between secured and unsecured credit cards is that you are required to make a deposit in order to open a secured credit card. This deposit is what secures your account, should you be unable to make a payment. Though secured credit cards are often easier to qualify for, the downside is that their interest rates can often be higher than with unsecured credit cards. In addition, their limits are often much lower than unsecured cards, and can come with costly annual fees.

Secured Credit Cards vs Prepaid Debit Cards

In use, secured credit cards may feel somewhat like prepaid debit cards. For both, you have to deposit money in order to spend any. However, secured credit cards don’t spend down the balance each with each purchase. Your deposit in a secured credit card is never used unless you don’t make payments. If you spend all of your money with a prepaid card, nothing further is required of you. Whereas if you spend all of your limit with a secured card, you must pay that amount back or make a minimum payment each month.

Prepaid debit cards also do not help you build credit. Their use is not reported to credit agencies, and you can’t graduate from one to a credit card. In addition, there may be hidden fees for transactions that can surprise you if you aren’t informed.

Should You Open A Secured Credit Card? 

Depending on your credit history, and your financial goals, a secured credit card can be a great option to help build credit. Though they are still “beginner” cards, it’s still important to use them responsibly. Experts often recommend avoiding carrying a balance with secured credit cards, as interest rates can be very high. You should not use a secured credit card to spend more than you can really afford. If you want to build credit, think you can keep your spending small, and pay off the balance in full every month a secured credit may be just the thing.

However, building credit takes more than simply opening a secured credit card. Practicing responsible financial management in all areas of your life is the best way to build a solid financial future.

Experian | Discover 1, 2 | Investopedia