A secured credit card can be a solid credit-building tool, whether you’re looking to establish credit or you need to set your credit straight.
“It’s so easy to get sideways with your finances,” says Paul Golden, managing director of media and communications for the National Endowment for Financial Education. “And it can take a long time to repair them and come out on the other end.”
According to a 2016 report from the Federal Reserve Bank of Philadelphia, having a secured credit card open for two years “is associated with a 24-point increase in median credit scores.” However, some secured cards come with drawbacks, which can include expensive fees, a high annual percentage rate or no path to an unsecured card. Here’s what to know before you apply.
What Is a Secured Credit Card?
People looking to apply for a secured credit card generally fit into two categories: consumers looking to establish credit, such as students or people who recently moved to the U.S., and consumers looking to rebuild credit, possibly from a previous bankruptcy or delinquent loan.
Just like a regular credit card, a secured card lets you charge purchases, up to a specified credit limit, and make monthly payments. If you don’t pay off the bill, the issuer will charge interest, called an APR, on the balance. Secured credit cards have an average APR of about 20 percent, according to U.S. News data.
Here’s the key difference between regular and secured credit cards: To get a secured card, you’ll need to put down a security deposit, which protects the issuer in case you default on payments. The deposit is usually equal to your credit limit, so even if you max out the card and fail to pay it off, the issuer has the funds at hand. But following the card’s terms and conditions can help ensure you’ll get the deposit back when you decide to close the account – or graduate to an unsecured card.
Pros of Secured Credit Cards
There’s a lot to like about secured credit cards, if you can find one that works for you.
Secured cards can help you build credit. “That’s the primary benefit,” Golden says. “Secured cards are great to build up your credit if you’re in a situation where you’re not likely to get an unsecured credit card.”
Although approval isn’t guaranteed, as issuers will usually check your credit report and ask about your income, people with low or no credit scores can still be approved. Here’s how to use a secured card to build credit:
- Pay the bill on time every month. This is the most influential credit score factor, so it will go a long way toward building healthy credit.
- Don’t close the account unless you’re upgrading to an unsecured card. A long credit history is good for your credit.
- Keep the balance low, around 30 percent of the credit limit or less.
Make these steps easier by using the card for just one or two bills every month and paying off the balance immediately. At the same time, make sure any other accounts, like loans, are in good standing so you’re showing good credit habits.
They can be a good learning tool. Secured cards are common among young people, typically because they haven’t had a chance to use credit. “If you are looking to show your kid how a credit card works in general practice, then a secured card provides a safe environment to do that,” Golden says. That is, he adds, as long as you can find a secured card that doesn’t come with expensive fees and a high APR.
It goes hand in hand with teaching young adults about budgeting. Leslie Tayne, debt resolution attorney and founder and managing director of Tayne Law Group, suggests figuring out exactly how you want to use the card, writing down your monthly expenses and tracking your spending. “Otherwise it’s a guessing game: Can I afford this or can I not afford this?” Tayne says. “It does require financial management on a very personal basic level.”
Cards may offer perks that rival their unsecured counterparts. Though you might only use a secured card temporarily, it’s nice to have benefits. Some secured cards come with perks like travel insurance, cellphone protection, credit-monitoring services and identity theft alerts. Rewards programs are rare on secured cards, but some offer redeemable points or cash-back programs based on your spending.
“You might be able to use those rewards to pay down some of the (credit card) bills,” Tayne says. “But if you’re going to spend haphazardly and not pay attention to your ability to repay the card, you’re going to end up in debt.”
You could potentially upgrade to unsecured status. Credit card issuers know secured cards aren’t meant to be used forever, so many automatically review your account after a certain number of months. If you’ve been using the card responsibly, such as by making on-time payments, the issuer may upgrade your card to unsecured and return the deposit. Once you get that deposit back, consider putting it in a savings account. It may come in handy down the road if you’re in danger of missing a payment on a credit card or bill.
Cons of Secured Credit Cards
Although the right secured credit card can improve your financial standing, some have drawbacks that can trip up your money situation.
They require a security deposit. Among the downsides of secured cards, “this is the big one,” says Golden. “For a lot of people who have poor credit or no credit, getting that deposit together is a struggle.”
That’s because they may already be in a financially fragile situation. According to the Federal Reserve Bank of Philadelphia report, people who apply for secured credit cards typically have lower income and low credit scores. And once you do hand the deposit over, you generally can’t access it, even in an emergency, unless you close the account.
They sometimes come with lots of fees. Secured cards charge fees just like unsecured credit cards do, but they may be extra burdensome for consumers who are already strapped for cash and have low credit limits. Most secured cards charge annual fees that range from $18 to $125, though most are around $30. Issuers could also charge fees you might not expect, such as monthly program fees, a paper statement fee or a cash security deposit payment fee.
Federal law restricts the amount of required fees that banks can charge during the first year of your account opening. The Credit Card Accountability Responsibility and Disclosure Act of 2009, known as the Credit CARD Act, says the issuer can’t charge more than 25 percent of the card’s limit in fees. So on a card with a $200 limit, required fees for the first year can’t exceed $50.
Some secured cards have a low credit limit. A handful of secured card issuers will allow credit limits of up to $2,500 or even $10,000, but the majority of issuers restrict credit limits to around $200 to $500. Here’s the catch: Keeping your balance at or below 30 percent is typically recommended to build healthy credit. On a card with a $500 limit, that would mean limiting your balance to just $150 or less.
“It’s really easy to get to that number,” Tayne says. And if you reach the max, “it’s not showing that you are very creditworthy.”
You might not be able to upgrade your account. Not every secured card issuer will graduate your card to unsecured status. If you decide to close the secured card and go with a different card, your credit may be affected if it shortens your credit history. To find out if an issuer will consider upgrading your card to unsecured, read the marketing language or terms and conditions. You can also call the issuer to ask.
Is a Secured Credit Card a Good Choice?
Secured credit cards may help you build credit and offer generous perks. But ideally, you’ll choose one with low or no fees and look for one that not only returns your deposit if you use the card responsibly but also reports your activity to the credit bureaus.
“You have to really research a card before applying for it,” Tayne says. “Shop around online and figure out which card makes the most sense.”