Secured Credit Cards
Consumers are often unsure of the differences between secured credit cards and unsecured credit cards, thinking that a credit card is a credit card, and that’s that. However, not only are these two types of cards different, but they also suit the needs of different consumer segments. Understanding how and why this is can help you save money as well as manage your finances more efficiently.
Unsecured credit cards are what most people consider “normal” credit cards, so the real question therefore is:
What is a secured credit card?
A secured credit card is a type of credit card that requires you to place a refundable security deposit in order to open it. The amount of this security deposit will serve as your credit line in order to protect the card’s issuer from the possibility that you might default on your obligation to pay back whatever you charge. In other words, any balance remaining on your account when you close it will be deducted from your security deposit, and only the difference will be returned to you. Because issuers therefore do not have to worry about the financial threat posed by consumer default, they are able to make these cards much more affordable for consumers, creating a win-win situation.
Like unsecured credit cards, secured cards report monthly usage information to the credit bureaus. In fact, secured and unsecured credit cards are indistinguishable on your credit reports, which means they are equally well-suited to credit building.
Why use a secured credit card?
Cost is obviously one of a secured card’s primary draws, but there are a number of others, including the following:
- Attainability: Most secured cards require a minimum deposit of $200, and if you can meet this requirement, have a valid Social Security Number (SSN), and are able to display the independent income or assets required to make monthly minimum payments you should be able to garner approval, regardless of how good or bad your credit standing may be.
- Credit line autonomy: Given that your security deposit doubles as your credit line, you can increase your spending power at any time by simply adding to your deposit. This is helpful to credit building efforts as well, since available credit is an important component of your FICO Score.
- Protection against overspending: The unique relationship between deposit and credit line also prevents overleveraging. With a secured credit card, there’s just no way you can spend more than you can afford to pay back.
Are there any disadvantages to using a secured credit card?
Secured credit cards offer a number of benefits to consumers, but lucrative rewards and zero percent interest rates don’t tend to be among them. This is not surprising, however, as such perks are primarily the domain of unsecured credit cards for good and excellent credit, for which secured cards serve as a stepping stone.
There are also not nearly as many different secured credit cards on the market as unsecured credit cards. Therefore, a relative lack of options from which to choose could be construed as a disadvantage.
Who should use a secured credit card?
There are a couple of different consumer segments for which secured cards are perfectly suited:
- People with limited credit: Students, recent immigrants, divorcees, and anyone who hasn’t used credit for an extended period of time may find it difficult to garner approval for an unsecured card or any type of loan. The relative lack of information in their credit files creates uncertainty in the minds of issuers over whether or not they’ll pay their bills, but the financial security provided by a secured card makes this a moot point.
- People with damaged credit: There simply isn’t a less expensive way to rebuild your credit standing than by opening a secured credit card. Even if you don’t want to make any purchases with your card, it will still be an excellent credit building tool given that it will report information to the credit bureaus on a monthly basis anyway.
How long does it take to build credit?
If you open a secured credit card in order to build or rebuild your credit standing, this is a very important question. Unfortunately, there is no concrete answer, as results depend on one’s individual situation. Nevertheless, you should see credit score gains after roughly a year of responsible secured card use (i.e. always paying your bill on time). At this point, you may be able to qualify for an unsecured credit card.
Simply understanding how secured credit cards work is only half the battle. You must also be able to diagnose your own credit card needs, determine whether or not to apply for a secured card, and which to apply for, if applicable. You also need to use your card responsibly, and if you find yourself unable to pay your monthly bill in full, it’s important that you place a new emphasis on budgeting. Secured cards can be extremely useful, but the cardholder needs to play his or her part as well.
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