Credit Cards can be a frightening financial tool, but when used correctly they can help build a solid credit history and credit score so you can qualify for affordable home mortgages and business loans. If you’re just starting to build a credit history or aim to rebuild a poor credit score you may want to consider opening a secured credit card.
What is a Secured Credit Card?
If you don’t have enough cash to cover the purchase of a hotel or airline ticket, then a credit card is the way to go. Typically, banks offer unsecured credit cards or lines of credit to individuals who have shown the credit bureaus they can handle their finances and are not required to offer a deposit or asset up as collateral. If you have no credit history or your credit is destroyed due to defaults, bankruptcy, foreclosure most banks usually will not qualify you for a unsecured credit card with affordable interest rates.
A secured credit card works like any other credit card except the cardholder will offer the bank a non-interest-bearing security deposit as collateral for the line of credit. As an added bonus, most reputable secured credit card companies report good faith payment history to the three credit bureaus so you can build or improve your credit score. And some allow cardholders to qualify for unsecured lines of credit in the future.
Every secured credit card is different. Banks offer a range of secured credit limits (with initial minimum deposits usually between $100- $5000) with varying annual fees, interest rates and benefits. Be sure to go with a FDIC-insured credit issuer. Compare how much each card will cost (from initial fees to potential cost of making minimum payments) and what benefits they will bring you in the long-term.
Note: Prepaid cards are not to be confused with secured credit cards. Prepaid cards do not report to the major credit bureaus and thus cannot help you build your credit.
How Does a Secured Credit Card Work
Apply. Deposit your money for collateral. Use your card. Build your credit score. It’s not so complicated. Once you’ve decided how much you need to deposit for a credit limit and which company will offer you the best terms, it’s pretty much like using any other credit card.
Here’s How a Secured Credit Card Works:
- Apply for a secured card online or with your bank
- Once approved, arrange to submit your minimum, refundable security deposit (in one lump sum payment or over time) to establish your credit limit
- Now you can use your secured credit card just as you would any other credit card
- Make payments for your purchased just a you would any other credit card. The balance payments are not deducted from the security deposit
- If you want to increase your credit limit, add more money to your security deposit
- Maintain a good credit history with the secured credit card and you may qualify for an upgrade to a regular, unsecured credit card
- Any late payments or missed payments may result in poor remarks on your credit report
- Default on the secured credit card and the bank will keep your security deposit (and will avoid collections as long as you don’t owe more than the deposit)
Just as with your unsecured credit card, you still want to make at least your minimum monthly payment, however, its ideal to pay your credit card balance in full each month instead of carrying a balance.
Can a Secured Credit Card Help Build or Rebuild My Credit Score?
The easy answer is yes, unfortunately the calculation of your credit score is a bit more complicated so there are benefits and potential drawbacks. How opening a secured line of credit is going to affect your score largely depends on your current credit situation. It is certainly a great way to begin establishing your credit history. And can rebuild a damaged credit score through some careful planning.
First of all, the secured credit card you choose should indicate they report to the major credit bureaus. If this is your first line of credit you should generate a credit score 6 months later. And if you’ve got a poor credit score, adding a secured credit card may not be enough to offset the damage.
In some instances, adding another line of credit and maintain a high balance on the card it can affect your credit utilization ratio – meaning your are using more of your available credit than the bureaus would like – and your credit score may be negatively impacted. Speak with a trusted financial advisor to determine exactly how a secured credit card might impact your personal finances.
What Happens if I Close a Secured Credit Card
– Will My Deposit Be Applied to the Balance or Will it Be Returned to Me?
The security deposit you use to open a secured credit card is similar to a security deposit for leasing an apartment or the 20% collateral you put down on a mortgage. It is a gesture of good faith that you will make your payments. If you have managed your secured credit account properly or maintained your apartment, then you should be eligible to get your deposit back after you close your account or move out.
If you close the secured credit card with an outstanding balance you risk forfeiting all of your security deposit – or at least the portion used by the issuer to cover your debt. Preferably you want to pay off the balance and collect your security deposit per the terms of your contract.
There are a number of ways to build and rebuild your credit worthiness.-Do your homework to pick a secured credit card which will work for your situation.