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What Is a Secured Credit Card?
As the name suggests, a secured credit card is secured by a security deposit, which the client pays to the bank. As the bank of America website suggests, those cards are designed to help to establish, strengthen, or to rebuild credit.
Many people might have a hard time getting a credit card due to the following reasons:
- No credit history
- History of late payments
- Low Credit score
- High debt-to-income (DTI) ratio
In all those cases, a secured credit card might offer a solution to the customer. In addition, due to the presence of a security deposit, it is much easier to get approved for a secured credit card than for regular credit cards.
Secured credit cards are less risky from a bank’s point of view; therefore, if you apply for a secured credit card and have a security deposit, it’s unlikely that your application will be denied.
Secured credit cards can be the first step toward building a solid credit score and payment history. Some banks even offer their clients free monthly credit score reports. In this way, customers can monitor improvements in their credit scores and keep up their motivation.
How Does a Secured Credit Card Works?
Now, the mechanics behind the secured credit card is quite simple. To open a credit card account, a customer must pay a security deposit to the bank.
The actual amount of deposit required varies. For example, the minimum security deposit amount at Bank of America is $200. There is also an upper limit of $5,000. Other banks have different minimum security deposit requirements
Customers cannot access the security deposit, once the credit card application is approved and the card activated. The initial credit limit will be equal to the deposit amount. If for whatever reason, the client fails to make payments or defaults on debt, then the bank uses the security deposit to recover its losses.
It is also helpful to point out that, if a client makes payments on time and improves his or her credit score, then the bank might decide to return the security deposit to a customer, even before the balance is paid in full.
However, it is important to note that this is far from guaranteed. In truth, such decisions are made on a case-by-case basis. In any case, if at some point in the future you close your account and pay your balance in full, then the bank will return your initial deposit to you.
Pay Attention to Credit Utilization Ratio
Another major consideration with secured credit cards is to keep the credit utilization ratio in mind. This is one of the major components of credit score and it measures the ratio of utilized credit compared to the total amount of credit limit. Credit bureaus typically recommend keeping this ratio at or below 30%.
To get a better idea of how to achieve this, here is a table below:
30% Credit Utilization
As we can see from the above, if you have just made a minimum security deposit, then it might be better to only spend $60 or less during each statement period. On the other hand, if you made a $5,000 deposit, then you can spend up to $1,500, without hurting your credit score.
How a Secured Credit Card Can Build Credit?
To be able to answer this question, we need to look at the components of the FICO score, as shown on the myfico.com website:
- Payment history – 35%
- Credit Utilization Ratio – 30%
- Length of Credit History – 15%
- New Credit – 10%
- Credit Mix – 10%
So, with this in mind, how can a secured credit card help you build your credit score? Firstly, we have a payment history, which represents the largest component of the FICO score.
By making payments on time you slowly build a good payment history, which can go a long way toward improving your credit score.
This will also have a positive impact on the third component of the FICO score, length of credit history. As months pass by, your credit history will become lengthier and as a result, your credit score will improve as well. This will take some time, but at the end of the day, it might be worth it.
Getting a secured card might have very little direct influence on the last two components. However, if you maintain the credit utilization ratio at 30% or below, as discussed above, this can also play a significant role in building a credit score.
Example of a Secured Credit Card
All major banks offer secured credit cards. To take one example, we can look at the Bank of America’s secured credit card.
- Annual Fee: One upside to using this secured credit card is that there is no annual fee, which helps customers to save money.
- APR and Intro APR – On the other hand, the standard annual percentage rate, also known as APR is around 24%, which is quite high. Also, the card has no introductory APR. The balance transfer fee is the same as the standard rate in the credit card industry, which is 3%. However, here it is helpful to keep in mind that you can avoid interest payments altogether if you pay your balance in full by the end of the statement period.
- Security Deposit: The minimum required security deposit is $200, but people can deposit up to $5,000. The initial credit card limit will be the equivalent of the security deposit. However, the website does say that the bank might decide to return the security deposit to the customer if he or she has a good payment history.
- Perks – Another important aspect of this secured credit card is that their owners in most cases get the same security benefits as other credit card holders. For example, customers are informed if there is some suspicious activity with their credit cards. People also can benefit from a $0 liability guarantee for fraudulent transactions.
Discover it® Secured
1-2% 2% cash back at gas stations and restaurants on up to $1,000 in combined purchases each quarter and unlimited 1% cash back on all other purchases
Match Bonus Discover automatically matches the cash back you've earned at the end of your first year, no limits
Bank of America® Customized Cash Rewards Secured Credit Card
1% – 3% 3% cash back in the category of your choice: gas, online shopping, dining, travel, drug stores, or home improvement/furnishings,2% cash back at grocery stores and wholesale clubs, unlimited 1% cash back on all other purchases
Secured Credit Card Pros and Cons
Just like any other bank product, secured credit cards do have some advantages and disadvantages.
Generally speaking, it is easier to get approval for secured credit cards compared to other types of cards.
Secured credit cards are designed for those customers who want to establish or rebuilt their credit history.
Most secured credit cards have very low or no annual fees.
You have to pay a security deposit to the bank to get a secured credit card.
The initial credit limit cannot be higher than the security deposit.
Most secured credit cards have no special rewards or bonuses
Now, some people might make the following argument: Since the credit limit size, in this case, corresponds to the security deposit, then you can spend all of the credit limits and make up for the expense, associated with making a deposit.
That is possible. However, it’s important to remember that building a good credit score is one of the main purposes of using a secured credit card. As explained above, if you utilize all of your credit limits, this can have a significant negative impact on your credit score.
In this case, it is fair to say that you can only utilize a credit limit which will be the equivalent of 30% of your security deposit, without damaging your credit score. So this is something to keep in mind when dealing with a secured credit card, issued by any financial institution.
Secured vs. Unsecured Credit Card: Key Differences
There is no denying the fact that there are many similarities between secured and unsecured credit cards. However, there are some differences to point out as well:
- Security deposit: To get a secured card you have to come up with at least the minimum required security deposit. This is not the case with an unsecured credit card.
- Required Credit Score: To get approved for most unsecured cards, you need a decent credit score. At the same time, you can get the most secured cards even with relatively poor credit ratings.
- Annual Fee: Most secured credit cards have no annual fees. There are some unsecured cards with no fees, but most of them do have annual fees.
- Rewards & Bonuses: Most secured credit cards do not offer their clients rewards, welcome bonus, or 0% introductory rates, as you'll need a good score to get these benefits.
As we can see from the above discussion, most secured credit cards only offer their clients the basic features of a typical credit card, without special offers or rewards.
However, this does not mean that you will never get access to those benefits. One obvious strategy here would be to build a good credit score with a secured credit card. After that, you can move on and apply for an unsecured credit card.
With an improved credit score, you are more likely to get approved for an unsecured credit card. You can choose one with the rewards which you can use.
When does it Make Sense to Use a Secured Card?
As discussed above secured credit cards do have their drawbacks and they are not for everyone. However, there are several cases, when it might make sense for you to apply for a secured card:
- No credit history – If you never had a credit card before and have no credit history, a secured credit card might be the solution.
- Low Credit Score – If you have a low credit score due to late payments or other reasons, a secured credit card can help you to rebuild your payment history and credit score.
- Improving Credit Score – Even if your credit score is normal, you might want to improve it to qualify for those credit cards which have stricter requirements
As we can see from the above points, the main purpose of secured credit cards is to establish or rebuild a credit history, as well as credit score in general. The fact of the matter is that in most cases, secured credit cards offer no short-term financial benefits.
The only financial benefit is the ability to qualify for cheaper loans and some credit cards with rewards, once you improve your credit score. This required patience and discipline. Achieving a good credit score might take from several months to several years, depending on your circumstances.
It is also helpful to keep in mind that the presence of a security deposit does not guarantee that your credit score will not go down if you miss a payment. Yes, in this case, the bank will be able to recover those losses from your deposit.
However, any missing payments will be as damaging to your credit rating, as with the case of other types of credit cards. To avoid this problem, you can set up alerts or automatic payments, so that you do not have to worry about forgetting to make a payment on time.
How to Apply for a Secured Credit Card
The application process for secured credit cards is very similar to any other type of credit card. The only major difference is the security deposit.
Here are the basic steps you need to take to get a secured credit card:
- Research: The first step is to research and find a secured credit card that best suits your needs. It might be preferable to find the one with no annual fees.
- Prepare a Deposit: The next stage is to come up with a security deposit. There is no standard amount, but most banks require at least $200 for a deposit.
- Apply: After that, you can apply for the secured credit card you have chosen, by online or mobile banking. Alternatively, you can visit the bank branch personally and submit your application there.
- Get Approved: If your application is approved, the security deposit will be taken from your account and the bank will issue you a card.
Generally speaking, applications for secured credit cards are more likely to be approved, than ones for unsecured credit cards. However, this does not mean that there is no chance of being denied.
If this happens, it does not mean that you should just give up. What you can do in this situation is to find another financial institution that offers secured credit cards and apply there.
It might also be helpful to increase the size of your security deposit, making it larger than the minimum requirement. In some cases, this might reassure banks that you are not a risky client.
The main purpose of a secured credit card is to establish or rebuild one’s credit history, as well as to improve a credit score.
The fact of the matter is that many people have no credit history and have a difficult time getting approved for a credit card. In this case, a secured credit card offers them an opportunity to get their first credit card and build their credit scores in the process.
To qualify for secured credit cards, you need to come up with a security deposit. The required minimum amount depends on the bank in question.
However, most banks require at least a $200 deposit for secured credit cards. You can choose to make a larger deposit. In any case, the initial credit limit will be the same as the size of your security deposit.
If you miss your payments or default on your credit card debt, then the bank will use this security deposit to recover any lost funds.
Most secured credit cards do charge interest unless you carry debt from month to month. However, interest rates on some of those cards can even be higher than on unsecured cards.
However, you can still avoid paying interest with those cards, if you pay your balance in full by the end of each statement period.
Yes, initially secured credit cards do require making a minimum deposit. However, after some period, if you have a good payment history, a bank might decide to return the security deposit to you.
So in this case, your secured credit card will function as an unsecured credit card.
Payments with a secured credit card are the same as with other types of credit cards. Most banks offer contactless wireless technology for payments. You can also use those cards for online purchases.