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How Secured Credit Cards Work

I’ve been reading a lot of credit and credit scores lately because a lot of people are focusing on cleaning up their personal finances during this recession. For folks to have no credit or poor credit, rebuilding or building up your can be difficult and expensive. If you can’t get unsecured credit to establish your history, the next best option is to get secured credit. If you need a car and can get a car loan, that’s the best way. If you don’t need a car or you can’t get a loan, the next best thing out there appears to secured credit cards.

Read on to learn more about secured credit cards, how they compare to a debit card, how they improve/build your credit score, and what to watch out for if you’re looking for one.

A secured credit card is just like an unsecured credit card with one important distinction. With an secured credit card, you are required to make a security deposit. The secured credit card company then issues you a card with a limit equal to the amount you deposited. From there, you use the card as you would an unsecured credit card. You can use it wherever you see the Visa or Mastercard logo, you will receive statements, and you’ll make payments on your balance. The only significant difference is that you must first make a security deposit (that’s the “secured” part).

Secured Credit Cards

Here is a popular secured credit card:

First Option Visa® Card [3] is another secured credit card that has a maximum limit of $5,000 and you will be approved regardless of credit history or income. No credit check is required and you are approval is guaranteed.

All companies will establish a lower and upper limit for the credit limit, usually between $300 and $5,000. Some cards will give you a credit limit of 90% (or some other percentage) of your security deposit. If you deposit $1000, they offer a limit of $900. They will specify this in the terms and conditions.

Why would you ever get a secured credit card? If you want to build or establish your credit and you can’t get an unsecured credit card. If you can get an unsecured credit card, there’s no point in getting a secured one.

Why not get a debit card? Debit cards don’t report to the credit bureaus because there is no credit involved. The bank isn’t lending you any money, they’re merely making it more convenient for you to spend the funds in your checking account.

But isn’t it like a debit card? No, when you charge a purchase to a debit card, the money is debited (withdrawn) from your bank account. When you charge a purchase to a secured credit card, your security deposit isn’t touched. You don’t pay for your purchases with the security deposit. You have to come up with other money to pay the balance with.

Secured Credit Card Fees

The big thing to watch out for with secured credit cards are the fees. Here are the fees you’re likely to see:

Converting to Unsecured Card

You’ll want to convert from a unsecured card to a secured card as quickly as possible, so ask potential secured credit card companies how many months of responsible credit usage would it take for you to get an unsecured card. Expect the answer to be about a year. After a year, you should check your credit score [4] anyway to see where you stand. If you can get an unsecured card, I’d recommend you get one with good rewards anyway.

What Else To Watch Out For

Be sure the secured credit card company reports to at least the three major credit bureaus every month. If you must, call and ask to see if they send monthly reports to Equifax, Experian, and TransUnion. You’re getting a card to improve your score, so don’t get one that doesn’t report your good activity! Credit reporting is optional, so companies don’t necessarily report good or bad behavior.

Ask how the fees are charged. Some will deduct it from your deposit. Others will charge them to your card. Be aware of how the company plans on assessing these because it can have big impact. If it’s deducted from your deposit, then you’ll have a lower limit. If they charge them to your card, they may assess interest before your next payment is required.

Review the grace period policy. With unsecured credit cards, you get a grace period if you pay off your balance in full each month. Some secured credit cards work the same way, you get a grace period if you pay off your balance each month. However, some secured credit cards don’t offer any grace period so the interest accrues immediately. You want to watch out for that.

You also need to ask if your security deposit earns interest. Some places will offer you a nominal interest rate on your deposit while others won’t offer any interest at all. While it’s nice to earn a little interest, I don’t think it’s a big deal either way but it’s not universal across all cards.

For more information about secured credit cards, I recommend checking out the Federal Reserve Board’s page on choosing a credit card [5]. It doesn’t specifically cover secured cards but does mention them and contains good general information about all types of cards.

Secured credit cards aren’t great products, they’re simply a means to an end for someone with little credit history or poor credit history. Many people have pulled themselves out of credit score purgatory with these cards, you just need to be aware of the pitfalls as well as the benefits. If you get one, it’s recommended that you make a few purchases on the card each month and then pay it off in full each cycle.

Have you ever used, or considered using, a secured credit card to establish or improve your credit?

(Photo: zebble [6])