What Is a Secured Credit Card – Pros & Cons for Rebuilding Credit
The negative effects of a bad credit score are familiar to anyone who’s been there:
The causes of bad credit are even more diverse.
Personal bankruptcy, foreclosure, and other adverse events can seriously impact your credit score.
In less dramatic fashion, so too can neglect. Past-due loan payments, high credit utilization ratios, and overenthusiastic credit application patterns all erode your credit score over time.
For many consumers, the absence of a meaningful credit history is the root cause. If you’ve never applied for a credit card or cosigned a loan, your track record (or lack thereof) isn’t likely to inspire confidence from prospective lenders, landlords, insurers, and employers.
Secured credit cards are designed for two types of consumers:
Secured credit cards have much looser underwriting standards than most unsecured cards, especially premium cash back credit cards and travel rewards credit cards with generous rewards programs, expansive lists of value-added perks, and high spending limits.
No-Credit-Check Secured Credit Cards
A few secured credit cards require no credit check at all. If they can scratch up the minimum required security deposit (more on that below), applicants are guaranteed approval. The catch is that no-credit-check secured cards tend to have higher annual fees, high APRs, restrictive terms, and no clear path to unsecured status.
Traditional Secured Credit Cards
Most secured credit cards do require a credit check. Precise FICO score requirements vary, but it’s very unlikely that you’ll qualify with a score below 500. FICO scores between 500 and 560 are iffy – some issuers might bite, some might not, and it may come down to extenuating factors, such as an open bank account or housing ratio. Most issuers that do run credit checks avoid applicants with recent or non-discharged bankruptcies. Unfortunately, the only way you’ll know for sure whether your application is approved is to apply.
Pro Tip: Our list of tips to improve your credit score rating has more simple strategies to improve your credit score and build your credit profile over time.
Secured credit cards have several common characteristics:
Pro Tip: Curious about how secured credit cards actually look in practice? Check out our list of the best secured credit cards for rebuilding credit. We regularly update it with the latest information and promotions, so it’s a great resource for the best possible deals on secured cards too.
You don’t need great credit to qualify for a secured credit card. That’s kind of the whole point. If you have a good credit score and strong credit history, you’re likely to qualify for an unsecured card with lower rates, better terms, and more generous rewards. Why would you choose an inferior option?
Virtually all secured credit card issuers report users’ credit utilization and payment patterns to the three major credit reporting bureaus.
If you hold up your end of the bargain and use your card responsibly, this regular reporting could raise your credit score and build your credit profile over time. Assuming no setbacks elsewhere, you’re likely to find yourself in a significantly better position a year or two down the road.
Pro Tip: Before you apply for a secured credit card, read the fine print or call the issuer to confirm that it does in fact report to the three major bureaus. With so many choices out there, you have no incentive to use a secured card with no possibility of building your credit.
Secured credit cards are decidedly nontraditional, but they’re still credit cards. With that designation comes some important privileges and conveniences. Two in particular deserve attention:
Many secured credit cards, though not all, earn interest on security deposits held in collateral savings accounts. In most cases, yields are nominal – less than 0.5% APY, and often less than 0.2% APY. Some secured cards backed by credit unions offer more attractive yields – as high as 3% APY, in some cases. Regardless, any yield is better than no yield when it offsets the (likely) recurring annual fee.
It’s not uncommon for secured credit cards to earn rewards, most often cash back or travel points at modest rates. The Discover it Secured Credit Card, for instance, earns 2% cash back on qualifying purchases made at restaurants and gas stations – up to $1,000 per quarter combined. All other qualifying purchases earn 1% cash back, with no caps on earnings.
Though secured credit cards’ relatively low spending limits are usually held out as a drawback (see below), the security deposit itself provides a de facto cap on credit card spending. Secured credit card users can’t fall too deeply into debt, if only because they can’t overspend their security deposits.
Many secured credit card issuers define clear “graduation” pathways for responsible cardholders. Precise policies vary, but cardholders who make timely payments can typically upgrade to unsecured cards in as little as six to nine months. (Some cards have longer runways – a year or longer.) If you’re happy with your current issuer and you don’t want to go through the hassle of searching for an unsecured card elsewhere, this is a great opportunity to take the next step in your credit journey.
Most secured credit cards require pre-approval credit checks. They thoroughly examine your credit history – the good, the bad, and the ugly.
Pre-approval credit checks look at your credit score too, of course. If you’ve had a major adverse event in the very recent past, such as a non-discharged bankruptcy, you’re unlikely to qualify for most secured cards. That’s sort of ironic, given that secured credit cards are designed to build credit for people who could use a hand, but it is what it is.
A few cards don’t require pre-approval credit checks, but they tend to have higher rates, more onerous fees, and less favorable terms overall. If you’re a first-time credit user or have truly abysmal credit, think carefully before applying for a secured credit card.
By and large, secured credit cards have higher interest rates than unsecured credit cards. There are some important and notable exceptions: DCU Visa® Platinum Secured Credit Card’s APRs start below 10%, a fantastic rate for any credit card. But, by and large, secured cardholders have to pay a premium for the privilege of using credit.
Most secured credit cards charge annual fees, usually between $25 and $50. That’s a distinct drawback relative to run-of-the-mill rewards credit cards and low APR products for consumers with good to excellent credit.
Secured cards that allow balance transfers and cash advances typically charge higher fees for those transactions as well – up to 5% of the transaction amount.
And cards with looser underwriting standards may impose additional, unorthodox fees, such as monthly insurance premiums. It’s not a given that issuers will be upfront about these fees, so it’s up to you to read the fine print in your credit card disclosures and check for complaints filed with consumer protection authorities.
A secured credit card is not a license to spend. Even if you have the means to make a sizable security deposit, you’re limited by issuer-imposed caps – rarely more than $10,000, and often less than $5,000. If you need to finance a major purchase, such as a big home improvement project or a new car, a secured personal loan (see below) is likely a better call.
With rare exceptions, you can’t overspend your secured credit card’s security deposit without paying off your card balance. This isn’t ideal for cardholders who want the flexibility to carry a balance from month to month.
Pro Tip: Be cautious with your secured credit card spending, even if your monthly income and spending limits tempt you to loosen your belt. The best way to build credit with minimal cost or downside risk is to charge a handful of purchases to your secured card each month and promptly pay them off in full.
Before you apply for a secured credit card, ask the issuer how it will look on your monthly credit reports. In most cases, the entry won’t look any different than an unsecured credit card’s. But some issuers add notes to secured credit card reports that give the card’s nature away. When you apply for another loan or credit card and the lender pulls your credit, they’ll see that you have an active secured credit card account. Depending on their underwriting practices, that could be a red flag that lessens your approval chances.
Credit is a privilege, not a right. If you’re not careful with your credit utilization or careless about when and how you make payments on your balance, you could actually hurt your credit score. Missing statement due dates is a big no-no, for instance. Be honest with yourself: If you’re not ready for a credit card of any sort, acknowledge that, work on your financial fitness, and circle back when you feel better about your ability to handle a credit card of your own.
When you send in your security deposit, you’re kissing it goodbye until you pay off your balance and close your account – or default, a much less favorable outcome.
If your cash flow is barely positive, it’s easy to envision a situation in which you’d need the funds earmarked for your security deposit. Do your budget a favor and wait until you have more financial breathing room to apply for a secured credit card, or look to an alternative that doesn’t require an up-front security deposit that’s then locked away for months or years.
Applying for a secured credit card is not an essential step on your credit-building or -rebuilding journey.
Millions of people for whom secured credit cards are technically appropriate never actually use them. If you’re wary of the secured credit card drawbacks cited above, these alternatives are legitimate and reasonably popular.
Secured credit cards don’t have a monopoly on the credit-building market. There’s a small but stable cohort of unsecured credit cards catering specifically to cardholders with sub-par credit. Some cards, such as Capital One Platinum Credit Card, cater to applicants with FICO scores below 600.
Unsecured credit cards don’t require up-front security deposits. The rub is that they typically have high regular APRs – in some cases, higher than secured credit cards’. Plus, their initial credit limits tend to be on the low side, often below $1,000. And their underwriting standards aren’t quite as lax as most secured cards’ – a recent bankruptcy will definitely disqualify you. High APR unsecured cards generally lack rewards programs, a drawback next to the more generous secured cards.
Like secured credit cards, secured personal loans are backed by borrowers’ cash. Unlike secured cards, which are revolving credit facilities, they’re fixed installment loans.
Secured personal loans have long been issued by banks and credit unions, where they’re sometimes known as “share secured loans.” They’re secured either by a share of the existing balance in the borrower’s savings account, or the balance in a collateral savings account opened specifically to cover the loan.
Compared with other types of secured loans, such as mortgages, secured personal loan rates are high. However, they’re not nearly as high as the rates on unsecured loans issued to credit-impaired borrowers, which can approach 30% APR. If your credit is really poor, your best bet is to work through an institution (preferably a credit union) with which you have an existing relationship.
In recent years, alternatives to the traditional secured personal loan model have emerged. Self Lender, an online lender with a branded credit product called the Credit Builder Loan, gives borrowers a one-year runway to build credit with monthly deposits into a collateral account. The deposits are reported as installment loan payments to the major credit reporting bureaus, theoretically improving the borrower’s credit score over time. Once the account is fully funded, the borrower can withdraw the full amount or roll it into a new Credit Builder Loan account to continue building credit. Since no credit score is required to apply, the Credit Builder Loan is ideal for first-time borrowers.
Many types of installment loans, both secured and unsecured, are available as cosigned loans. Your cosigner is a trusted individual, most often a parent or spouse, who agrees to assume responsibility for the loan.
If you default on the loan, the cosigner essentially agrees to clean up your mess by paying the remaining balance. For this reason, lenders hold cosigners to high standards – they need very good credit scores and strong, lengthy credit histories.
Since cosigners expose themselves to substantial financial and credit risk, they’re in short supply. If you know someone willing to go out on a limb to cosign a loan for you, you owe them one – and you owe it to yourself not to let them down.
By the same token, if you do know someone willing to cosign a loan with you, and you’re quite confident that you can pay it off without trouble, it’s wise to take that opportunity rather than apply for a secured credit card on your own.
“Entry-level unsecured rewards credit cards” is not an official term used by credit card companies (or anyone else I’ve come across, for that matter). But it does accurately describe a class of credit cards that lives a step or two up from the high-APR unsecured credit cards referenced at the top of this section.
Entry-level unsecured rewards credit cards are often variants of better-known rewards credit cards. For instance, the Capital One QuicksilverOne Cash Rewards Credit Card is a less generous iteration of the Capital One Quicksilver Cash Rewards Credit Card, a much better-known product backed by a multimillion-dollar advertising campaign. (Pitchmen have included Samuel L. Jackson, Charles Barkley, and Spike Lee.)
Entry-level unsecured rewards cards typically have higher regular APRs, less generous rewards programs, lower spending limits, fewer value-added benefits, and (in some cases) annual fees. They’re designed for consumers who’ve begun their credit-building journeys elsewhere – perhaps with a cosigned loan – but have yet to arrive at a place where premium credit cards and prime-rate home loans fall from the trees.
Another type of credit card that arguably qualifies as an entry-level product is the student credit card.
Most student cards are designed for college students. Like general-audience entry-level unsecured cards, they’re designed for consumers with limited or challenged credit, but applicants need to prove that they’re enrolled in a higher education program (or recently graduated) to qualify.
Most student credit cards earn modest rewards, usually in the form of cash back. Some offer good student discounts or bonuses – for instance, Discover it Chrome for Students pays you $20 every year your GPA stays above 3.0.
Further Reading: There’s one last type of plastic card worth mentioning: the reloadable prepaid debit card.
Prepaid debit cards don’t report to the major credit reporting bureaus, so they’re not suitable alternatives to secured credit cards for those seeking to build or rebuild their credit. But they’re quite useful for budgeting purposes and can even replace traditional bank accounts in the right circumstances.
At one of the first jobs I ever held, a bottom-of-the-barrel call center gig, my new supervisor closed the group orientation session with a matter-of-fact prediction I’ll never forget: “In three years, none of you will be here.”
The remark was ominous, sure, but refreshingly realistic too. He was just stating the obvious, in effect: “You shouldn’t want to work at an entry-level job paying just north of minimum wage for any longer than you have to. Move up, or we’ll help you move out.”
Like entry-level jobs, secured credit cards are a means to an end. They serve a vital purpose for credit-building consumers who can’t yet qualify for unsecured credit cards. Used responsibly, they serve as a bridge to credit cards with more attractive rates and terms, not to mention home loans and other vital types of credit – just as menial, low-wage jobs lift hardworking young people up to more meaningful work.
But, like the jobs in which most of us started, secured credit cards aren’t built for the long haul. Why aspire to hold onto the same secured credit card for five years when you can slowly but surely improve your credit with responsible use and graduate to an unsecured alternative in 12 or 24 months? Greener pastures await.
Do you have a secured credit card? Have you used one in the past?
Editorial Note: The editorial content on this page is not provided by any bank, credit card issuer, airline, or hotel chain, and has not been reviewed, approved, or otherwise endorsed by any of these entities. Opinions expressed here are the author’s alone, not those of the bank, credit card issuer, airline, or hotel chain, and have not been reviewed, approved, or otherwise endorsed by any of these entities.
Brian Martucci writes about frugal living, entrepreneurship, and innovative ideas. When he’s not interviewing small business owners or investigating time- and money-saving strategies for Money Crashers readers, he’s probably out exploring a new trail or sampling a novel cuisine. Find him on Twitter @Brian_Martucci.
Comments Disclosure: The below responses are not provided or commissioned by the bank advertiser. Responses have not been reviewed, approved or otherwise endorsed by the bank advertiser. It is not the bank advertiser’s responsibility to ensure all posts and/or questions are answered.
What Is a Secured Credit Card – Pros & Cons for Rebuilding Credit
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