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Secured Credit Cards

If you are trying to establish a credit history, or perhaps need to rebuild one after some financial setbacks, secured credit cards can be a great option. These cards are generally accepted by all retail merchants who accept regular major credit cards for purchases.

How a Secured Credit Card Works

Building good credit (or re-building a blemished credit history) is very important to your personal financial life. But sometimes it can seem like a Catch-22. To get a credit card, you need to have a good credit history. But to have a good credit history, you need to have a credit card. It's a dilemma a lot of people find themselves facing, especially in today's tough financial climate.

This is where a secured credit card can really make a difference. Secured credit cards differ from regular credit cards in one important way. They are backed ("secured") by a deposit which the customer is required to make into a savings account. This money serves as collateral for the credit card and cannot be touched- unless the cardholder fails to pay.

If you have a fully secured card, your credit line will be equal to however much security deposit you provide. If you deposit $500, then your credit limit will be $500. The security deposit gives lenders confidence that you will pay back your credit card charges and any fees associated with the account.

Most secured credit cards help you build (or improve) your credit history because the lender reports your account activity each month to the major credit reporting bureaus- Equifax, TransUnion, and Experian. This can be a huge benefit to you down the road when you want to obtain additional credit, such as a car loan or another credit card.

You should consider a secured credit card the same as you would a regular credit card. This means making timely payments each month and paying off the entire balance due whenever possible. This saves you interest charges and indicates to lenders that you take your financial obligations seriously and know how to handle your credit. It's crucial to use your card responsibly. Some lenders will convert your secured card to a regular credit card after you have shown consistent, on-time payments and responsible use over time. But this is never a guarantee.

The Advantages of Secured Credit Cards

There are several advantages that secured credit cards offer people who are looking to establish a credit history or improve their credit score.
  • Simple Approval Process - Since anyone applying for a secured credit card is required to deposit money into a saving account as collateral, lenders tend to accept nearly all applicants. Consumers who may not be approved for a traditional credit card can generally obtain a secured card.
  • Improve Your Credit Score - Most lenders report to the three main credit bureaus each month so as long as you make timely payments, your credit score should increase. A higher credit score normally translates to more favorable terms and conditions for any future loans which you may want.
  • Build or Re-build Credit - If you are just starting out financially and need to establish your credit history, a secured credit card can be a big help. If you have a less-than-perfect credit history, responsible use of a secured credit card can be a good way to get back on track.
  • Security Deposit Guarantees Your Line of Credit - The lender will take your security deposit in the event you default on your payments so you won't be forced to take on new debt.
  • Earn Interest on Deposits - Some lenders offer interest on the security deposit you place with them. You may earn a small amount as long as you make payments and do not carry a balance.
  • Conversion to a Regular Credit Card - Some secured credit cards automatically convert to a traditional credit card after a certain period of time (generally 18 months to 2 years). To qualify for this, you must make consistent, on-time payments and never exceed your credit limit.

The Disadvantages of Secured Credit Cards

There are a few disadvantages associated with secured credit cards but they are still your best option if you have no other choices.
  • High Fees - Secured credit cards can come with application fees, processing fees, and annual fees. Be sure to compare different lenders to find the best deal.
  • Security Deposit - Secured credit cards require a deposit in the amount of the credit limit. If you are just starting out or are recovering from a financial setback, coming up with a relatively large amount of cash can be difficult.
  • High Interest Rates - Secured credit cards sometimes come with higher interest rates than traditional cards. A way to avoid this is by paying off your balance in full each month.

Final Thoughts

Building a good credit history or improving upon a bad one may seem impossible if you're just starting out. But a secured credit card can help you establish a solid credit foundation on which to build a strong financial future. Of course, this is all dependent on your managing your card responsibly.

By learning (or re-learning) good financial habits, you should be able to improve your credit history and increase your credit score over time. Always remember the rules of responsible credit card use:
  • Pay off your balance in full each month.
  • Never exceed your credit limit.
  • Always make consistent, timely payments.
  • If you must carry a balance, try to keep it below 30% of your credit limit. Pay it off as soon as possible.