Secured credit cards are an incredible way to establish your credit history of you have none or if you have prior credit problems like delinquencies, bankruptcy, or charged-off accounts.
Whether you're seeking to build your financial credit history from scratch or trying to build a good credit report, a secured credit card has its associated perks and drawbacks.
According to a report retrieved from the Federal Reserve Bank of Philadelphia in 2016, a client having a secured credit card account running for two years is associated with a 24-point surge in their meridian credit scores.
However, some secured credit cards could have expensive interest rates, a crazy annual percentage rate (APR), or no provision for a path to a secured credit card.
Considering the associated perks and downsides, we've compiled what you need to know about a secured credit card.
A secured credit card would be one of the options to consider if you have an insufficient credit history or simply trying to build your credit history from scratch.
Essentially, you make a deposit – usually $500 or more – as collateral for payments you make with the card.
In this case, the money you deposit with the credit card issuer is used to cover up your outstanding balances in case you default.
Some card issuers might deduct the balance from your deposit in case of a single default, while others may deduct the amount in case of severe late payments – spanning in the range of 3 months or more.
Typically, secured credit cards have a limit of about 50-100% of the amount deposited. This means that if you made a $1000 deposit, you'd be allowed to utilize at most $500 (50%) or the entire amount ($100%). In rare cases, card issuers might allow you to utilize up to 150% or 200% of the amount borrowed.
The credit company will pay interest on some or all of the cardholder's collaterals. Depending on the card company, the interests might be placed on your savings, checking, or routing account – which means you might be required to open one of these accounts if you don't have one.
Contrary to standard unsecured loans, secured credit card loans have lower underwriting standard thresholds.
Some unsecured credit cards require no credit check at all, and if they can get a guarantee of the lower threshold of the minimum deposit, you can be guaranteed of approval. This approach usually works for no-credit-check credit cards, but the downsides are typically high yearly fees as well as extreme APRs.
The second way to get approved for a secured credit card loan is the traditional secured credit cards that require a credit check. The exact FICO score requirements might show some disparities, but your odds of qualifying with a score of below 500 are incredibly low.
While a score of between 500 and 560 might guarantee you a credit card loan, some issuers might consider factors like housing ratio or an open bank account to avoid applicants with bankruptcies.
Secured credit cards are ideal for someone trying to build or rebuild their broken credit.
Below are some of the reasons why credit cards can be suitable for you.
One of the most noteworthy benefits of credit cards is helping you build your credit.
Unlike unsecured credit cards that require a minimum deposit, you can get a secured credit card with insufficient credit history.
While some issuers might report to the credit information centers that you have a secured card with them, it makes no significant difference with the bureaus as long as you pay your bills on time.
Keep in mind that you should clear your bills on time and keep the account open as long as unless closing the account would incur additional costs.
Besides, it would be great if you keep your utilization ratio, preferably under 30%, and ensure that any other outstanding loans are in good condition to build a comprehensive credit history.
Putting a deposit as a collateral for secured credit cards may be a negative item for secured credit cards, it can be more of help if you use it wisely.
This approach works since you're the one who controls the amount you're using and not the card issuer.
While issuers may give you a limit ranging from $300 to $1000 – which is incredibly low – you can start with a deposit of $1000 and keep your utilization under $300.
Remember that the idea here is to build your credit history and not necessarily get immense monetary value from the card.
Another incredible advantage of having a secured credit card is that a mainstream issuer would allow you to upgrade the same to an unsecured card.
If you have no credit history, the issuer will review your account's activity in as little as 6 to 8 months and upgrade your card.
Essentially, your card number would remain unchanged, you'll get your deposit back, and you'll continue using the same card with a possibility for an increase in credit.
Such cards are prevalent among young people primarily because they haven't had the chance to use credit before and are trying to experiment the same.
At the same time, some parents who want to teach their children how to use credit find secured credit cards as one of the best options to do the same.
As long as you use a credit card without high charges and exorbitant APR fees, it would undoubtedly be a great way to learn how to budget and use your money appropriately.
It starts by writing down precisely what you want with the card then tracking your expenses and spending behavior.
After defining the fine line between what you can afford and what you need, you'll start seeing your secured card as an incredible way to manage your finances at a personal level.
With a secured credit card, you can earn rewards and cashback on purchases using the same card.
If you clear your balances on time before the interest charges accumulate, you can use the rewards and cash backs to clear your outstanding balance.
Overall, the reward programs would be fruitful and incredibly help you avoid a repeated circle of debt.
While secured credit cards are often considered "non-traditional," they come with a mammoth of conveniences and flexibilities to make emergency purchases and reservations.
When something unexpected comes your way, you can use your credit card's limit to make purchases and charge it on your card.
Additionally, some hotels, car rental services, and travel merchants give credit card users incredible discounts that they would have otherwise failed to have if they paid using cash or their debit card.
Several secured cards require some pre-approval credit checks aimed at a thorough examination of your credit history to evaluate the good and bad components.
This examination entails looking at your credit score as well and having adverse credit elements like unpaid collections, non-discharged bankruptcy, and severe delinquencies.
It sounds ironic since secured credit cards are designed to help people build their credit history, but this process usually happens before issuers give out secured credit cards.
However, some cards do not require pre-approval checks but tend to have expensive fees, less favorable rates, and are generally unsuitable for starters.
If you're applying for this card for the first time, you must be careful and confirm whether the terms are friendly before committing yourself.
The need to secure a deposit is one of the most significant downsides experienced by people with less or no credit history.
Most applicants of a secured credit card are financially unstable, and producing this deposit would undoubtedly be a daunting task for them.
For instance, Philadelphia's Federal Reserve Bank reported that people who are applying for secured credit cards have low-income and low-credit scores.
Consequently, this scenario presents a daunting task for them since they can hardly access the deposited money during an emergency unless they close the account.
Secured credit cards have significantly higher interest rates and fees than unsecured cards.
Most issuers charge an annual fee of between $25 and $50 and charge up to 5% for cash advances and balance transfers.
Besides, cards with lower underwriting standards may have additional charges like monthly premiums. Worse still, the company wouldn't inform you about the hidden fees, so it's up to you to go through the fine print and check for any complaints filed against the company regarding such charges.
Cumulatively, the interests, hidden fees, and monthly premiums make secured credit cards incredibly expensive.
The majority of secured credit card issuers allow credit limits ranging from 200 to $500 – with only a handful giving up to $10,000.
Remember that the best credit utilization ration is usually under 30%, so if you have a limit of $300, you should keep your utilization, preferably under $90.
Reaching this limit is very easy, and it would show that you're not good at utilizing credit.
Generally, you need to have good fiscal habits and make the wisest decisions to ensure you maintain an appropriate utilization ratio and avoid tarnishing your credit history.
Secured credit cards certainly have perks like helping you build your credit and having the provision to upgrade to an unsecured account.
The question of whether a secured credit card is appropriate for you or not depends on the issuer's requirements, and the card holder's needs.
It can be an excellent choice for you if you have an insufficient credit history, but remember to make timely payments, and keep your utilization ratio below 30% to build a comprehensive history.