If your credit score is terrible – i.e., simply nonexistent – obtaining a secured credit card is probably one of the simplest and easiest ways to repair your credit score. They’re not sexy or glamorous – but they work.
Think of it this way: A credit card has a certain level of trust in you, but not fully yet. It’s more like, “Show me that I can trust you before I give you a lot of money.” This is precisely how a secured credit card works.
Some people have no chance whatsoever of obtaining an unsecured credit card. Their credit history is littered with late payments, collection agencies and all sorts of mistakes made during a previous period. Then you have those just entering the world of credit who possess what lenders refer to as a “thin file” meaning lenders have no previous history on this person.
Instead of the bank absorbing all of the risk associated with issuing new credit to someone else’s behalf, a person applying for a secured card will put down a financial security deposit on the secured credit card, which will act as their line of credit. For example, if an applicant sets aside $500 for a security deposit and receives a $500 limit, it is as simple as that!
A secured credit card operates similarly to a traditional credit card for most daily transactions. You can swipe, tap or enter a secured credit card number online. Cashiers are unaware that the card is secured. Websites have no varying perception of a secured card. The difference between a secured credit card and a traditional credit card exists only in the background.
If a secured credit card is used responsibly, by making payments on time and not going to the credit limit, the deposit sits unused. Eventually, you will receive the deposit back. If payments are missed, the bank will withhold the deposit and terminate the account. There is no compromise on this agreement.
When a secured credit card is used properly for six to twelve months, the bank may provide an option to ‘graduate’ from a secured credit card into an unsecured/regular credit card. In doing so, you may receive all or a portion of your deposit back.
With your graduated unsecured credit card, your credit limit will be increased from your secured credit card limits, your deposit will be returned to you, and finally, the bank will trust you to use an unsecured account without collateral. This is the overall purpose of a secured credit card.
Although secured credit cards usually carry a higher interest rate, there is a risk that this may discourage some potential users. However, as long as a secured credit card is being used in the manner intended—paying the total balance each month—the interest rate becomes negligible.
Limit your spending on a secured credit card to the entire amount owed at the end of each month. Do not try to pay “most of the total”; do not plan on catching up with payment(s) later. You will NOT get credit for your responsibility until you have successfully paid off the total balance each month.
The maximum unpaid balance should be less than 10% of the card’s credit limit. If the credit limit is $500; try your best to keep your unpaid balance at approximately $50 or less. Having up to 30% of your unpaid balance but lower is always better for credit score, etc. Just the small act of consistently keeping your balance under 10% can help build your credit score quicker than most people think possible.
A secured credit card utilizes a portion of your deposit (which was given to the bank) as collateral for your card account. After you make the initial deposit, the bank issues you a card based on the amount of your security deposit. When you have established your creditworthiness through maintaining your credit account(s) responsibly (i.e., payments are made on or before the due date), you will have proven that you can handle credit responsibly as long as your payment habits remain consistent.
The process to obtain secured credit is relatively simple. You submit an application with personal and financial information; wait to receive approval for credit; and then pay a security deposit before you receive your credit card via standard mail.
The one rule that should always apply when applying for a secured credit card is to avoid any credit card that requires monthly or annual fees whenever possible. Since your security deposit is tied to your credit account, there is absolutely no reason whatsoever to pay an additional fee just to receive access to your credit.
A second rule indicated that switching a secured credit card to an unsecured credit card requires an account change. Generally, switching one account for another is preferable for your credit score than closing one and opening the other.
The third rule indicates that while it is perfectly fine to earn rewards with your secured credit card, it is not required. The majority of secured credit cards do not provide cash back options; however, a few do. If you have access to rewards as a way to build your credit history, that definitely adds to the overall experience, but it has no value whatsoever.
Never look at secured credit cards as a permanent solution for improving your credit history. You can utilize them until your credit history improves.
In summary, if you need to build your credit history, but are unable to qualify for a standard credit card, think of secured credit cards as an essential tool for establishing your credit report. Use secured credit cards wisely by maintaining low balances and paying the balance in full on a monthly basis, and continue to allow the time necessary to achieve a better credit rating overall.
