You know that credit is an important part of your financial life; it’s essential in a variety of situations, from renting an apartment to refinancing your student loans and more. But how can you establish or rebuild credit if you have no to low credit? A secured credit card might save the day.
What is a secured credit card?
“For anyone that is looking to improve their credit score, a secured credit card is a great option,” says Matthew Coan, owner of the credit card comparison website Casavvy.com. “Secured credit cards require that you put down a deposit up front that will most likely act as your credit limit on your secured credit card.” If you put down a $500 deposit, that $500 will serve as your credit limit.
The term “secured” means that the card is backed by collateral — in this instance, your cash deposit. Most credit cards are “unsecured,” meaning they do not require a deposit or any other type of collateral.
“If you fail to make any of your payments, [lenders] will use your deposit to cover what you owe. If you stay on top of your payments, then when you are ready to close out your secured credit card account, you will get your initial deposit back,” says Coan.
This type of card is typically good for people with low to no credit. If you don’t have any credit history or you’ve recently declared bankruptcy, you can use a secured credit card to rebuild credit. You get the opportunity to prove you can make on-time monthly payments, while your credit card issuer takes on little to no risk since you’ve already put down a cash deposit.
The pros and cons of a secured credit card
Before applying for a secured credit card, make sure it’s the right option for you. According to Shay Olivarria, a financial education speaker and the author of 10 Things College Students Need to Know About Money, the pros and cons of getting a secured credit card include:
- Easier to get than an unsecured card
- You get to decide what your credit limit will be (with your deposit)
- Most issuers report to the three credit bureaus, so your credit scores will increase over time with on-time payments
- Have higher interest rates than an unsecured card
- Might have a smaller credit limit because you have to deposit the funds to get the credit
- Some unscrupulous secured card issuers charge up-front fees
- Some cards do not report to the big three credit bureaus
What to look for in a secured card
Before you decide to get a secured credit card, it’s crucial that you ensure the credit card issuer does report to the three credit bureaus: Experian, TransUnion, and Equifax. If you sign up for a secured credit card and it is not reported to these bureaus, the card will do little to help you establish or rebuild credit. Read your card’s terms and conditions to check that your information is reported correctly.
In addition, you’ll want to read the fine print and understand any fees that may be associated with getting a card. “Unfortunately, even though the point of a secured credit card is to help people rebuild their credit, some issuers charge an annual fee or application fee,” says Priyanka Prakash, a finance specialist at Fit Small Business. “Make sure you know what you’ll be charged before signing up.” You’ll also want to understand any minimum or maximum deposit requirements and make sure you have enough cash on hand for the deposit.
Secured credit card best practices
To maximize the benefits of getting a secured credit card, pay off your balance in full and on time each month, and keep your balances low. Your payment history, as well as your credit utilization (how much available credit you use), are important factors when building your credit, so charging small amounts to your card is better than maxing out your limit each month.
Lastly, find out if it’s possible to upgrade to an unsecured credit card after successful repayment for a certain period of time. “Typically, if you make on-time payments for 1 to 1.5 years, the credit card issuer will let you ‘graduate’ to an unsecured credit card. Some issuers will even increase your limit on your secured card after some successive on-time payments without requiring additional deposits,” explains Prakash. Moving on to an unsecured credit card can help you continue building your credit, without the use of a deposit.
If you have no to low credit—or have recently been rejected for an unsecured credit card—you may want to get a secured credit card to rebuild credit. Having strong credit can ensure you get approved for renting that dream apartment, and can open doors to student loan refinancing. Now that you’ve answered the question “What is a secured credit card?” you’re ready to start improving your credit. If you do your research and manage your purchases wisely, a secured credit card might be your ticket to get back on track.
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