The catch-22 of building credit is that you need to have access to and use credit in order to improve your credit. But often, without a solid score or an established history, it is difficult to qualify for borrowing opportunities, such as credit cards, in the first place.
A secured credit card can make landing an opportunity to prove yourself, credit-wise, a bit easier. While you will have to be in the financial position to hand over an initial cash deposit, from there, if you use your account responsibly, you can start moving on up in the credit world and eventually access better cards.
What is a secured credit card?
A secured credit card works much like a regular credit card, except for the fact that a security deposit is required when you open the account. This deposit “reduces the risk to the credit card issuer: If you don’t pay your bill, the issuer can take the money from your deposit,” said NerdWallet. This is why secured credit cards are generally easier to qualify for and more accessible to those with poor or no credit.
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Secured cards tend to have lower credit limits compared to the more standard unsecured credit card, with the limit typically equal to the amount of the cash deposit made upon account opening. So, for example, if you “make a $200 security deposit, you’ll receive a $200 credit limit,” said CNBC Select.
How can a secured credit card help establish credit?
One of the “biggest pros of secured credit cards is that they’re available to customers with poor or limited credit,” said WalletHub. This is primarily because secured credit cards are backed by collateral — that initial security deposit — which the issuer can seize if payments are not made. Unsecured credit cards, by contrast, are backed only by the cardholder’s creditworthiness, which is why for these cards, an applicant’s credit score and history are weighed heavily.
Still, unsecured credit cards “report account activity to the major credit bureaus just like unsecured cards do,” which means “cardholders can begin to rebuild or establish credit by using the card responsibly,” said WalletHub. Responsible use means consistently making on-time payments and maintaining a low credit utilization ratio by not using too much of your total available balance at any one time.
Are there any drawbacks to secured credit cards?
Depending on your financial situation, coming up with the initial deposit required for a secured credit card may not be easy, especially since those funds will continue to be tied up while you have the card open. The “required security deposit typically starts at $200, but you may have the option to make a larger or smaller deposit,” said Experian.
Just keep in mind that this deposit typically represents your credit limit, or the amount you can spend with the card. Not only can a low limit “reduce your financial flexibility,” it “also makes it easy to use a high percentage of your available credit, which can negatively impact your credit score,” said Experian.
Plus, while it is generally easier to get approved for a secured credit card, “you’ll still need some kind of income to be approved,” and a “major negative on your credit report, such as non-discharged bankruptcy, may also prevent you from qualifying,” said WalletHub. If you are approved, paying off your balance in full is essential — not only for building credit, but also because the APR on a secured card is typically higher.
