Secured Credit Cards
What are secured credit cards?
Unsecured credit cards are what you typically think about when you hear the word “credit card.” You can use them wherever VISA or Mastercard are accepted. They do not require a cash deposit, so the lender assumes a higher level of risk and is generally not reimbursed if the borrower pays late or defaults on what they owe.
Despite this key difference, secured and unsecured credit cards function similarly. Both offer cardholders a set amount of available credit. They might give the cardholder the ability to earn cash back, points or other rewards. Both secured and unsecured credit cards also may charge interest and fees on outstanding balances, and you will generally be expected to make a minimum payment each month. Failing to do so for either type of card could result in damage to your credit scores.
However, unsecured credit cards are often harder to qualify for than secured cards. Since the lender is assuming a certain amount of risk, they generally screen applicants more rigorously to make sure they will be responsible cardholders.In exchange for this exclusivity, unsecured cards usually offer lower interest rates than secured credit cards. Plus, because the account doesn’t have to be backed by a deposit, unsecured credit cards may offer the cardholder a much higher credit limit than they could qualify for with a secured card.
The big draw of secured credit cards is that they are typically designed for those who are looking to establish a credit history, or rebuild their credit. Therefore, they are more accessible for people who have low or no credit scores.With responsible use, you may also be able to use your secured credit card to improve your credit health over time and eventually qualify for an unsecured credit card.
Why are they important?
Payment history makes up 35% of your credit score. That makes having a positive history just as important as removing the negative credit items. You should also consider using credit builder loans in conjunction with a secured line of credit. Together, these products let you create a positive history that will rocket your credit score.
What are the benefits of a secured credit card?
Secured cards are issued by most well-known credit card companies and banks. Similar to a credit card, you have to apply for a secured card. Once you’re approved, you can use your secured card for things like buying groceries or for booking a vacation—everyday expenses that you can repay immediately.
Some card issuers review accounts occasionally and sometimes grant credit limit increases without requiring an additional deposit. There’s a possibility the card can be converted to an unsecured product, which means the credit card issuer will return your security deposit.
Secured credit cards are often used as a stepping-stone to approval for an unsecured credit card. Once you’ve improved your credit scores and shown financial institutions you are able to use credit responsibly, you may be able to transition to an unsecured credit card.
Secured cards are not without their risks. They tend to have:
- High fees and interest rates. Secured credit cards may charge high application, processing or annual fees. Additionally, these types of cards typically have high interest rates because credit card issuers may expect high default rates from people with lower credit scores.
- Low credit limits. Because your credit limit is typically based on your security deposit, it can be quite low, which is a drawback if you are looking to make large purchases. Low credit limits also may increase your credit utilization rate, which is the amount of credit you use compared to the total amount of credit available to you, generally expressed as a percentage. A credit utilization rate of 30% or less can help improve your credit scores. Therefore, if you pay a $300 deposit and your credit limit is $300, you will need to keep your monthly spending under $100 to maintain a favorable credit utilization rate.
- You’ll need to have cash up front. One of the biggest benefits of having a credit account is that it provides you with access to funds you may not be able to afford otherwise. If you find yourself strapped for cash, it may be difficult to cover the deposit that a secured credit card requires.
I’ve got one. What’s next?
Now that you have an unsecured card and have successfully improved your credit, you may qualify for lower interest rates on mortgages, cars and other big-ticket purchases. If you use your card properly, your credit score should improve over time. Once your score has improved, you have several options. You can keep your secured credit card, close it out, or ask your issuer about upgrading to an unsecured card, which may be better for your credit score than opening a new account.
In fact, some secured credit card issuers will automatically refund your deposit and convert your account to an unsecured card after a period of positive credit behavior.
Just remember: Despite the less stringent approval requirements for a secured credit card, failing to make payments can still hurt your credit scores. Even if your funds are secured, it’s important to use your credit card wisely and pay your balance on time.
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