Pros and Cons of Secured Credit Cards
Is a Secured Credit Card Right For You?
One of the toughest times to get a credit card is when you have bad credit or no credit at all. The trouble is, you often need a credit card to start building a good credit history, but you also need a good credit history to get approved for many credit cards. If you can't get approved for a traditional credit card, a secured credit card is an alternative worth considering.
What's a Secured Credit Card?
Secured credit cards require a deposit that serves as collateral for purchases you make using the card. If you default on your payments, the card issuer keeps your deposit. Otherwise, as long as you keep your account in good standing your credit card issuer will return your deposit to you after a certain number of months or when you close your account.
The credit limit on your secured credit card typically will be equal to your security deposit. In some cases, your credit limit can be bigger than your security deposit, depending on the card you choose and your credit rating. The Capital One Secured Card, for example, allows some applicants to pay a $49 or $99 security deposit for a $200 credit limit.
Even though you make a security deposit for a credit limit, you can use the secured credit card just like you'd use any other credit card. Swipe it for purchases up to your credit limit and make timely payments toward your balance each month.
5 Good Things About Secured Credit Cards
Secured credit cards can be a good option for building or rebuilding your credit. There are five benefits that stand out for consumers with blemished credit or no credit at all.
- You can often get approved for a secured credit card when you can't get approved for a traditional credit card. Paying the security deposit shifts the credit risk away from the credit card issuer.
- They typically report to credit bureaus. Unlike a prepaid credit card which functions more like a debit card, a secured credit card will send your account history to the credit bureaus to be included in your credit report.
- A secured credit card can help you establish or re-establish your credit. Since payments are included in your credit report, paying on time and managing your balance will help improve your credit score. After raising your credit score, you may be able to qualify for a regular credit card.
- Your security deposit is used only if you default on your payment. Unless your defaulted balance is more than your deposit, you won't get sent to collections for defaulting on your payments. Though the card issuer will keep your deposit, you don't have to worry about debt collectors hounding you for missed payments on the card. The late payments still will hurt your credit score.
- You can earn rewards on purchases with some cards, such as Discover and Navy Federal's secured cards. If you pay your balance regularly before interest charges accrue, this can help to offset the amount of your security deposit.
Drawbacks to Using Secured Credit
While secured credit cards can be appealing for those trying to improve their credit scores, there still are a few disadvantages.
- It might be difficult to come up with even a couple of hundred dollars to make a security deposit. If you do have that money, it might be better spent paying off some outstanding debt. Try setting aside $25 to $50 each month until you've saved up enough for the security deposit.
- There may fees in addition to the deposit. Depending on the card you choose, you might have to pay an application fee, processing fee, or an annual fee to have your secured credit card. This increases the cost of having the card. Shop around and select a card with the lowest fees.
- You may have to pay a higher interest rate. Secured credit cards don't usually offer competitive interest rates because of the risk of default. To avoid high finance charges, pay your balance in full each month.
With the right secured credit card, the drawbacks are manageable and a small price to pay for the benefit of being able to add positive payment history to your credit report. Consider a secured credit card as a stepping stone toward qualifying for a better credit card in the future.