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What is a Secured Credit Card?

Robinhood LearnJuly 2, 2020
Democratize finance for all. Our writers’ work has appeared in The Wall Street Journal, Forbes, the Chicago Tribune, Quartz, the San Francisco Chronicle, and more.
definition

A secured credit card is a credit card where you provide a security deposit, and the card issuer bases your credit limit on that deposit.

🤔 Understanding secured credit card

Many lenders won’t give you a credit card unless you have good credit. Secured credit cards are a way for people with poor or no credit to get a credit card and start building credit. When you open a secured card, you give a cash deposit to the card issuer (usually as cash deposited to a CD or savings account), and the issuer bases your credit limit on that deposit, typically making it equal to the deposit that you made. In a way, you’re giving the card issuer money to lend back to you so that you can prove your ability to make payments. Once you build up your credit, you can graduate to an unsecured card and get your deposit back.

example

Suppose you want to open a credit card but have trouble getting approved for an account, so you decide to apply for a secured credit card. You apply for a secured card from the fictional issuer Lenders-R-Us, and they approve your application.

You submit a $500 deposit to Lenders-R-Us, and the company holds it for you, giving you a credit card with a $500 limit. You then spend a year using the card and making monthly payments. After the year, you’ve built your credit score enough that Lenders-R-Us returns your $500 deposit and lets you continue using the card.

Takeaway

A secured credit card is like lending money to yourself to prove you can pay it back…

When you open a secured credit card, you give some money to the card issuer. The card issuer then lets you borrow money from them, usually up to the amount of cash you offered as a deposit. Effectively, the lender lends your own money back to you. This gives you the chance to build a payment history without putting the lender at risk — because they’re only lending you money that you gave them.

Tell me more...

What is a secured credit card?
How does a secured credit card work?
Who uses secured credit cards?
Do secured credit cards help build credit?
How long does it take to raise credit?
What are the pros and cons of secured credit cards?
How do you use a secured credit card wisely?

What is a secured credit card?

A secured credit card is a type of credit card that requires a security deposit.

A typical credit card is an unsecured, revolving line of credit. The card issuer agrees to lend you money up to a specified credit limit. You can use the card to make purchases, adding to your credit card balance. As long as you don’t exceed your limit, you can keep using the card to buy things. Typically, the card issuer bases your credit limit on a combination of your credit score, your household income, and how long you’ve had the card.

With a secured credit card, you need to give the card issuer some form of collateral before they give you the credit card. Most often, the collateral is a cash deposit held in a savings account or a CD. Usually, the card issuer will set your credit limit equal to the value of the security deposit.

Because you provide collateral, the card issuer takes on much less risk by giving you a secured credit card. In many ways, you’re giving the card issuer money which it then lends back to you.

Having a secured credit card helps you build your credit, which may help you qualify for an unsecured card in the future. Some secured providers automatically return your deposit after a set period of timely payments, graduating you to an unsecured card.

How does a secured credit card work?

Secured credit cards work just like other credit cards. The primary difference between secured and unsecured cards is that you have to provide a security deposit before you receive your card.

Like most credit cards, your experience with a secured card starts with the application. Most card issuers will ask you to provide a variety of information on your application, including your name, address, and Social Security number. You might also have to give information like your monthly housing costs and annual income.

If the lender approves your application, the next thing they will ask for is a security deposit. Most cards have a minimum deposit amount, often in the $300 to $500 range. With many card issuers, you’re welcome to provide a larger deposit. Making a bigger deposit will increase your credit limit.

Once the lender approves your application and you submit your security deposit, you’ll get your secured credit card in the mail. Just like a regular card, you can use the secured card at stores or online to make purchases.

At the end of the statement period, you’ll get a bill outlining all of your purchases, a minimum payment amount, and a due date. You must submit payment before the due date. If you don’t, it can hurt your credit and incur late payment fees.

If you choose not to pay your full statement balance, you’ll also accrue interest on the card. Interest rates on secured cards tend to be higher than typical credit card rates.

Like other credit cards, secured credit cards carry fees. Unfortunately, secured cards typically have higher costs than standard cards. You’ll likely have to pay an annual fee to keep the card open, and some cards might have monthly fees. Services like cash advances or additional cards also tend to carry higher costs when you’re using a secured card.

Perks, like extended warranty protection or cashback rewards, are rarer, but there are secured cards that offer them.

Who uses secured credit cards?

Secured credit cards are typically designed for two groups of people.

The first group is people with no credit history. Having no credit can turn into a chicken and egg problem. Lenders won’t give you access to credit if they can’t see that you have a history of making payments, but you can’t build your credit history without getting a loan. Some lenders can be more flexible, and there are student cards that help young people in this situation, but some adults might not be eligible for student cards and struggle to build credit.

A secured credit card is much easier to qualify for because the lender takes on nearly no risk. Someone with no credit history should have little trouble building their credit score with a secured card.

Secured credit cards are also useful for people who have damaged their credit and need a way to start rebuilding it. If you have a bad credit score, you’ll likely struggle to find a lender who is willing to give you a loan without collateral. Qualifying for a secured credit card is much easier and can help people with bad or poor credit start rebuilding their scores.

Do secured credit cards help build credit?

Yes, secured credit cards can help you build credit. Building credit is one of the top reasons to apply for a secured card.

Just like standard credit cards, your card issuer will report your activity to one or more credit bureaus. If you make on-time payments and keep your debts low, you can build your credit over time.

How long does it take to raise credit?

How long it takes to build credit can vary depending on the person and whether they had any credit history before getting a secured credit card.

If you have no credit history, you can build a good score in just a few months by making timely payments. If you have poor credit, it might take longer because you’ll need to make more payments to offset the negative marks on your credit report.

What are the pros and cons of secured credit cards?

The most significant benefit of secured credit cards is that they are far easier to qualify for than unsecured credit cards. Because you give the lender collateral equal to your credit limit, the lender takes almost no risk by giving you a secured credit card. This gives people who cannot otherwise get a loan the chance to build their credit score.

Unfortunately, the ease of getting a secured card does not come free. The downside of secured cards is that they tend to be more expensive than their unsecured counterparts. Most carry high annual fees and interest rates. They also generally don’t offer benefits like rewards to offset these costs.

Secured cards also tend to have lower credit limits than unsecured cards. Most issuers base your credit limit on the size of your security deposit. If you need a limit of a few thousand dollars, you’ll need to have a few thousand dollars to deposit.

How do you use a secured credit card wisely?

The most important thing to do with a secured credit card is to make sure that you use it well and build your credit.

To start, use the card to make a few small purchases. Don’t buy anything that you can’t afford to pay off. When you receive the bill, make sure that you send a payment before the due date. Ideally, pay the statement balance in full. If you carry a balance from month to month, you’ll pay interest.

If possible, you should sign up for alerts and automatic payment for your card. Alerts can help you find out if someone uses your card without your permission or if you’re nearing your credit limit. Automatic payments help you avoid accidentally missing a monthly payment and incurring fees and interest.

You should also try to keep your credit utilization rate below 30%, to help improve your credit score. So, if your secured credit card limit is $500, try to maintain a balance of no more than $150 ($500 x 30%).

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