When they’re used correctly, credit cards are one of the best ways to build credit. But if you have bad credit or a thin credit history, you might have trouble getting approved for a card. It’s a classic catch-22.
Secured credit cards were designed for people in your scenario. While they have a few quirks you won’t see in traditional credit cards, they are more easily accessible and they can help you start building credit immediately.
Here’s how secured credit cards work.
Who Secured Credit Cards Are For
Secured credit cards serve two main audiences:
• People who want to improve their bad credit
• People who want to build upon a thin or nonexistent credit history
If you have bad credit or you’re just starting to build your credit profile, you can benefit from a secured card’s credit requirements, which tend to be looser than many traditional cards. However, approval is not guaranteed; depending on the state of your credit, your application could still be rejected.
How Secured Cards Work
Opening a secured credit card requires you to make an upfront security deposit to the credit card company. You will need to be ready to provide this deposit once your application is approved.
Typically, the amount of your deposit determines your credit limit on a 1:1 basis; for instance, a $1,000 deposit will get you a card with a $1,000 credit limit, although some card issuers may offer a credit line that exceeds your security deposit. Most cards will require a deposit of at least $200.
The reason for the security deposit is simple: as a person with poor or nonexistent credit, you pose a greater risk to the card issuer because they aren’t confident that you will be able to make your payments. The security deposit provides insurance; if you stop paying, they will keep your money.
Beyond that, secured credit cards work just like regular cards. You can use them to make purchases, they require monthly payments, and they charge interest if you don’t pay your balance in full each month.
Some cards will increase your credit limit or even refund your deposit after a certain time frame, either automatically or at your request.
How Secured Credit Cards Build Credit
Secured credit card activity is reported to the major credit bureaus, just like traditional cards. If you use your card wisely, it will help you build the following factors that influence your credit score:
• Payment history: by making timely payments every month, you will build a positive payment history.
• Account mix: if you also have installment accounts (loans with fixed monthly payments for a predetermined time frame), a credit card will show you can manage multiple types of accounts.
• Debt utilization: if you keep your card balance low (under 30%), you will demonstrate the ability to responsibly manage your credit card balance.
• Average age of accounts: the older your accounts, the more they help your credit score. Over time, your credit card will help you increase the average age of your accounts.
Choosing a Secured Credit Card
The right card depends on your specific situation. Before you start researching cards, you should know where your credit stands and how much you can afford to put down for a security deposit.
You should try to find a card with a competitive annual percentage rate (APR), but keep in mind that secured credit cards tend to have higher interest rates than some of their traditional counterparts. Look for a card with a low (or no) annual fee.
While this isn’t the norm, some major credit card issuers like Discover even have secured credit cards with rewards. Make sure to evaluate all your options, and weigh the costs of any card before you apply.