Secured Credit Card Explained
Whether you're new to credit, or have had some bad experiences with credit, if you're looking to build your credit one of the first stops most people suggest is a secured credit card. It's an excellent tool that lenders love because it comes with almost no risk to them and gives you an opportunity to prove your creditworthiness.
So let's take a closer look at secured credit cards: what they are, how they work, and who needs them.
What is a Secured Credit Card?
A secured credit card is a financial product designed for individuals who may not qualify for traditional unsecured credit cards due to a lack of credit history or a less-than-ideal credit score. To obtain a secured credit card, the cardholder is required to make a security deposit with the issuing bank. This deposit serves as collateral, minimizing the risk for the bank.
The deposited amount typically determines the cardholder's credit limit, which can range from a few hundred dollars to several thousand. It's essential to understand that a secured credit card is not a prepaid card; rather, it operates similarly to a standard credit card.
How Does a Secured Credit Card Work?
Secured credit cards function like a bridge between a traditional credit card and a debit card. Here's a step-by-step breakdown of how they work:
As mentioned earlier, to open a secured credit card, you must provide a security deposit. This deposit is held by the issuing bank and is typically equal to the credit limit assigned to the card. It remains untouched as long as you use the card responsibly.
Your credit limit is determined by the amount of your security deposit. For instance, if you deposit $500, your credit limit will also be $500. This limit represents the maximum amount you can spend using the card.
Your credit limit is the same as your security deposit, because if you spend money and fail to make the required payments, your creditor will take the unpaid debt out of your security deposit. This is how they minimize risk while still providing credit to borrowers with less than stellar credit.
Credit usage and regular payments
You can use your secured credit card just like a regular credit card. Make purchases, pay bills, and use it for various financial transactions.
It's crucial to make at least the minimum monthly payment on time. Timely payments positively impact your credit history and score, which is one of the primary purposes of using a secured credit card.
Interest and fees
Secured credit cards may come with interest rates and fees, similar to unsecured credit cards. It's essential to read the terms and conditions provided by the issuing bank to understand these costs. The best way to use a secured credit card is by only spending as much as you can afford to pay off by the end of the billing cycle.
Perhaps the most significant advantage of a secured credit card is its ability to help you build or rebuild your credit. While the security deposit helps mitigate risk for the lender, you still get credit for using the card wisely. Responsible usage and on-time payments demonstrate your creditworthiness to credit bureaus.
Secured to unsecured
Most secured credit cards aren't secured forever. Typically after six to 12 months, the card can be converted to a regular, unsecured credit card. At that point, assuming you're still in good standing, your security deposit will be returned to you.
Advantages of Secured Credit Cards
Secured credit cards offer several advantages, making them a popular choice for those looking to improve their credit standing:
- They help you build credit: As mentioned, using a secured credit card responsibly can significantly boost your credit score over time.
- They're accessible to most borrowers regardless of credit history: Thanks to the deposit secured credit cards are fairly easy for individuals with limited or damaged credit histories to obtain.
- They're safe to use: It's difficult to abuse a secured credit or to create a burdensome amount of debt. As a learning tool, they promote financial discipline and responsible spending.
- They work just like any credit card: Although your credit limit may be low, you can use secured credit cards for everyday purchases, online shopping, and even travel reservations.
Whether you're new to credit or looking to make a fresh start, a secured credit card can be a great tool to help you build stronger credit. And if you need more help and advice on improving your credit and building stronger finances, MMI offers free financial counseling. Available 24/7, online and over the phone, we can help you review your situation and discover the best ways to make the most of your money.