How do you get good credit if you have no credit or build better credit if you have poor credit?
That is one of the biggest conundrums facing almost anyone wishing to build their financial future or become more financially secure. Fortunately, there are several ways to achieve this seemingly insurmountable task, one of the quickest, easiest and most effective being secured credit cards.
In this article, you will learn, in detail, the answers to these two essential questions:
- What is a secured credit card?
- How do secured credit cards work?
By the end, you'll be armed with the information you need to set yourself (back) on the path to your financial goals and dreams.
What Is a Secured Credit Card?
A secured credit card is a way to build credit with no credit or poor credit by providing the security to back any purchases you make with the card.
Essentially, you act as your own lender, while the bank or credit union issuing the card merely acts as the administrator:
- Processing purchases and refunds
- receiving and applying payments
- reporting your activity to the credit agencies
It is this last action, in particular, that allows you to use secured credit cards to build good credit.
Why Use a Secured Credit Card
You may be interested in using a secured credit card if you've repeatedly been denied a regular credit card every time you've applied.
Whether you don't get approved for a regular credit card because you have bad credit or because you simply have no credit history yet, a secured credit card can help you improve that state.
You may also be interested in using a secured credit card if you can only get approved for a regular credit card with an exorbitantly high interest rate.
The interest rates on secured credit cards aren't exceedingly low either. However, they may be lower than some regular credit cards you may get approved for with no credit or poor credit.
Likewise, you may be interested in using a secured credit card if you can't get a high-enough credit limit through regular credit cards to suit your needs.
All else being equal (like interest rates,) you may decide to take out a regular credit card for whatever credit limit you can get, and then take out a secured credit card for the remaining difference you think you'll need for a practical credit limit that will really suit your needs.
Why Build Good Credit
Of course, you may be asking a more fundamental question yet, when considering whether to take out a secured credit card or any kind of credit card at all, that being: what do I need good credit for?
Here are just some of the possible answers:
- To buy a home
- To buy a car
- To take out a loan to pay for a child's education
- To take a much-needed family vacation
- To pay for a well-deserved date
- To handle an immediate, short-term emergency
- To pay for an unexpected fine, penalty or fee
- To cover yourself for minor daily needs when you fall slightly short before payday
- To help your own children get started on the path building good credit while they're still young (by adding them onto your cards)
How Do Secured Credit Cards Work?
When you sign up for a secured credit card, you must make a cash deposit into a new account created for you by the card issuer on your behalf.
Generally, the issuer dictates a minimum amount you must deposit to qualify for a card (and/or a particular interest rate,) though you can typically deposit as much as you want.
A quick scan of popular secured credit cards available today reveals a common minimum deposit of $200, though you can find secured cards with lower minimum deposits required.
This cash account acts as collateral to secure any purchases you make against it, in case you default on payment. In other words, your credit limit is the same size as the size of this account.
If you want to increase your credit limit, you can simply deposit more money into this account.
This secured account is often an interest-bearing account, much like a money-market savings account, allowing you to earn interest on your deposit for as long as the account remains open.
Not all secured credit card accounts are interest bearing, however, so be sure to read the prospectus carefully to find out before signing up for a secured credit card.
This is also a refundable deposit, meaning that, if, at any point, you cancel your secured card and close out your account, as long as your account is in good standing, you will receive your entire deposit back.
Likewise, you can receive your deposit back if you upgrade your secured card one day to an unsecured card (more on this below.)
Secured vs Unsecured Cards
Other than the fact that your credit limit is linked to a cash balance you deposited into an account to secure that amount, a secured credit card acts exactly like a regular credit card, in that:
- You can use it to make purchases in person and online or over the phone anywhere that regular credit cards are accepted.
- They'll typically bear the familiar MasterCard, American Express or Visa logo.
- You receive a monthly statement with a minimum balance due.
- If you do not pay your minimum balance by the due date, you can be charged penalties and/or late fees.
- If you pay less than the total balance due on the card in any given month, interest will be applied to the remaining unpaid balance for the subsequent month.
- If you default on payment, you could lose some or all of your deposit.
And lastly, once again, all your activity is reported regularly to the credit reporting bureaus: Equifax, TransUnion and Experian. That means on-time payments, late payments and overdue or defaulted payments all appear on your credit reports, generally within one month of the action occurring.
Best of all, neither credit reports nor credit scores make any distinctions whatsoever between unsecured and secured credit cards.
This is also one of the key distinctions between a secured credit card and a prepaid debit card, which offers you many of the same benefits but does not report to the credit bureaus and, therefore, does not help your establish, build, improve or repair credit.
Remember, the benefits of secured credit cards are only attainable if you use them properly. Use them improperly, however, and you can produce the opposite effect: establishing poor credit, which, in some cases, can be considered worse than having no credit at all.
Pros and Cons of Secured Credit Cards
- Easy to qualify for and get approved for with little to no credit or poor credit
- The confidence of peace of mind of having a credit card to use wherever credit cards are accepted
- A greater ability to meet your needs, weather emergencies and improve your quality of life
- The pride of credit-card ownership
- The ability to establish and build credit, if you have no credit, or repair bad credit
Note, however, that, while secured credit cards are easier to get approved for, approval for secured credit cards is not 100% guaranteed.
If you have no credit or poor credit, then it may be best to find a secured credit card that does not require a credit check in order to get approval.
Most significantly, you may need to demonstrate that your income justifies the size of the credit balance you are seeking and that your monthly expenses do not exceed that income.
- The issuer may charge additional fees, like monthly or annual fees or per-transaction fees.
- Good credit behavior won't typically raise your credit limit; only an additional deposit of funds into your secured account will do that.
- You typically cannot take out a loan against your card for any amount greater than the balance in your secured account.
- They don't usually offer introductory APRs or balance-transfer APRs, and rarely offer bonuses or rewards.
Note that you can also find partially-secured cards, though they are rare. With these cards, you can get a credit limit higher than the amount you deposit into your secured account.
Similarly, after you display good credit behavior with a fully-secured credit card, the issuer may opt to increase your credit limit without requiring you to add additional funds to your secured account.
When Should You Transition to an Unsecured Credit Card?
Watch your credit score as you use your secured credit card over time. Many agencies offer services to help you monitor your credit, including the major credit bureaus, though there are also third-party services that offer to monitor your credit score.
Many of these agencies and services charge a fee for this, and those that don't will typically require you to allow them to track your purchases for marketing purposes and/or agree to receive targeted marketing offers.
Note as well that, while you can order a free copy of your credit report from each of the three major credit reporting bureaus each year, that does not include your credit score.
However you decide to monitor your credit score over time as you use your secured credit card, when you notice your credit score climb to an acceptable level (such as above 700,) you can contact the secured card issuer to request they upgrade your secured credit card to an unsecured credit card.
If they approve your request, you will, then, receive back the funds you deposited into the secured account.
You credit limit for that unsecured card, however, may be different, including, potentially, being lower.
Partly, it can depend on how your issuer issues your unsecured card.
Sometimes, an issuer will simply transfer the credit limit from your secured line of credit over to your unsecured card.
This is the preferred method, as it does not require you to apply for a new credit card, which can have its own negative impacts on your credit score.
If you do have to apply for a new, unsecured credit card, whether with the same issuer or a new one, you may still be able to seek added benefits like:
- Lower interest rate
- Smaller monthly payments
- Better fees
- Credit card rewards
How Long Does it Take to Build Credit with a Secured Card?
Based on the prior experience of others, it seems to take approximately one year of using a secured credit card regularly and responsibly to build a high-enough credit score to qualify for an unsecured credit card.
The Best Way to Use a Secured Credit Card
The best way to use a secured credit card is to only use it to make purchases that you can pay off in full when each statement comes due. Never carry a balance, or only carry a low balance.
Remember, a credit card—including a secured credit card—is not meant to help you live outside of your means.
It is to help you weather temporary lean times for the short-term, such as to buy lunch before payday and handle an emergency car repair, and establish creditworthiness for larger scale needs and wants in the longer-term, such as to get a car loan or a mortgage on a home.
By only buying what you can pay for in full when the statement for that month arrives, you build a consistent history of responsible credit card use.
That means you must actually use your secured credit card in order to reap its benefits for your credit score and credit history. Simply having the credit card in your name and possession is not enough.
Therefore, be prepared to use your secured card responsibly when you take one out. Not only do you have your creditworthiness to lose, but you could also lose the entire amount you deposited into your secured account (depending on how badly the account is in default.)
Now that you can answer the questions "what is a secured credit card" and "how do secured credit cards work?" as well as anyone, what do you do next?
If you're interested in taking out a secured credit card or simply discussing your options further with an expert in Jacksonville, the Duval County area and surrounding Northeastern Florida, you can give us a call at 904-723-6330 or take a look at our secured credit card options.
Remember to always read any secured credit card agreement carefully to make sure you're clear on all the terms and conditions, including the APR and fees. And if you don't understand something you read, we are standing by to help you make sense of it.