If you have a low credit score — or no credit history — you may not have found an issuer that will approve you for a conventional credit card.
You have four options if you want a credit card and have a bruised credit score or no credit history:
With a secured credit card, the card issuer will require you to open a savings account and deposit a cash amount before it will issue you a card. The issuer can use the funds in your savings account to satisfy payment obligations if you do not make your payments. With secured credit cards, you'll often pay higher annual fees and finance changes, and you might encounter other charges — like application, maintenance or processing fees.
A secured credit card can help you repair your credit and establish a credit history to ultimately qualify for an unsecured credit card. Once you've proven yourself — through a record of reliable, on-time monthly payments and responsible use of the secured card — your card issuer may graduate you to an unsecured credit card. Or, you can then successfully apply to another unsecured card issuer.
Credit Cards by the Numbers
Sources: Gallup, Experian, Federal Reserve
Pros & Cons of Secured Credit Cards
Pros
The bar for approval of a secured credit card is set relatively low. Having a savings deposit as collateral means that card issuers willingly take on little or no risk in approving the card. Unlike approval for an unsecured credit card, the secured card issuer won't overly concern itself with your credit score or lack of credit history.
Good payment history with a secured credit card is a proven way to establish or rebuild your credit history and score. Knowing from the outset that 12-24 months of on-time monthly payments may be the difference you need to qualify for an unsecured credit card is motivation to exercise discipline in your credit card behavior.
The lowered credit limit of secured cards forces you to restrict your expenses and do away with frivolous spending. If you're shopping for attire for an upcoming wedding you'll be attending, you'll think twice before dropping $200 for an outfit instead of searching for an equally flattering option from your existing wardrobe.
Cons
You need upfront cash to open a secured credit card, which may be a challenge in itself. And once you do provide it, you won't be able to access the funds if an emergency arises. Even after you close your secured card account, the company usually requires a waiting period before it releases the funds.
The Credit CARD Act of 2009 prohibits fees from exceeding 25 percent of your deposit in the first year, but secured credit cards' multiple fees—annual fees, application or processing fees—can quickly add up. Interest rates are also much higher than unsecured credit cards. Don't be shocked to run into rates higher than 20 percent.
Secured credit card limits typically constitute several hundred dollars, a small fraction of available limits for unsecured cards. A credit limit of $300 might prove inadequate, especially if the credit card is your only one. The limit may barely cover your grocery expenses, considering that the monthly food cost for a woman 19-50 years old averages $259.
11 Key Features to Shop For in a Secured Credit Card
When it comes time to shop for a secured credit card, it pays to do your homework and carefully review offers. Avoid falling prey to the many marketing scams that target consumers who have difficulty getting approved for a credit card. Less-than-honest companies know that consumers with poor credit or inadequate credit history are more likely to overlook red flags.
Look for these 11 features as you shop for a suitable secured credit card:
Many secured credit cards charge annual fees — $40 is typical — and sometimes even monthly fees. However, there's no law requiring credit card issuers to charge annual fees.
Enough issuers do not charge these fees so you should be able to find a card low or no fees.
As part of your goal to create a positive credit history or improve your credit score, plan on paying off balances in each billing cycle. However, you'll want a low interest rate if you occasionally find yourself unable to pay off the full amount and carry a balance to the next cycle.
Seek out a card with low interest. A lower interest cost can help deflect the snowball effect that interest can have on your debt. Remain committed to paying off your balance every month
Look for a cardholder agreement that specifies the qualifying time to convert your secured credit card to an unsecured card. Many card issuers are upfront about the time requirement — often good standing for 24 consecutive billing cycles — after which time you can apply for an unsecured card.
Find card issuers that automatically convert your secured card to an unsecured card after a specified number of on-time payments.
Not all secured card issuers report payment history to the three major credit bureaus — Equifax, Experian and TransUnion. Look for an issuer that reports payment history to the three major credit bureaus. Without it, you won't see any changes to your credit history or credit score. Some companies only report negative payment history, such as late payments, so you need to determine whether the card issuer will report complete payment history. Also keep in mind that some companies, in reporting to the credit bureaus, will specify your card as secured.
Choose a company that does not report the secured credit card detail to the credit bureaus. Also, keep tabs on your credit reports to check to see if your account is reported, and to watch for improvements in your score.
Look for a card with a well-known payment network — Visa, MasterCard, Discover or American Express — especially if it is your only credit card. Being part of a vast payment network means that you can use your card anywhere that card type is accepted.
Visa and MasterCard are much more widely accepted than American Express or Discover, so gravitate towards Visa and MasterCard unless you have a great reason to choose American Express or Discover.
Determine how your card company calculates your card credit limit, which is based on the amount of your savings deposit, the collateral. Many card issuers issue you a card with a credit limit equal to 100 percent of your deposit. In other words, if you deposit $500, your credit card limit is $500.
Find if your credit card issuer will allow you to increase the secured amount over time and allow you to deposit more funds into your secured savings account. Also, don't let your balance get too high. Keep your use to a maximum 50 percent of the limit each month. For example, if your limit is $750, determine if $375 sufficiently covers your credit needs.
Grace period means two things in the credit card world. One grace period is the time from the transaction until the card issuer starts charging interest. The other, the billing grace period, is the time from the date the card issuer send the bill until the payment is due. By law, the billing grace period must be 21 days or more.
Keep track of your payment dates to keep your payment history stellar. Also, choose a secured credit card that offers an interest-free grace period, so that you can repay your bill in full each month without incurring an interest charge.
Look for a credit card that does not restrict your card use to certain types of purchases.
Avoid a card that allows you to use your card for purchases from a card issuer's catalog only.
Go with a reputable large bank or financial institution, or established community bank or credit union. Getting a card through well-known banks — Bank of America, Chase or Capital One — or a local credit union can help you avoid unscrupulous practices. Many scams lure you in with promises of guaranteed or immediate approval.
Don't let a celebrity or financial guru endorsement lower your guard. Do your homework and check card fees and terms. More than one celebrity-branded credit card has gone down the tubes over exorbitant fees to the point of usury.
Some card issuers pay interest on the savings account deposit backing the credit card. Interest is an option not required by federal law.
Find an institution that offers interest on the amount you deposit to open your secured credit card. Keep in mind that interest rates on saving accounts today are near-zero, so don't expect credit card issuers to offer much here.
You can benefit from a secured credit card that offers extra perks, such as travel insurance, extended manufacturer's warranties on purchases, and credit scores.
Some perks are useful — especially free FICO credit scores for consumers building their credit scores.
How to Use a Secured Credit Card Wisely
Responsible use of your secured credit card builds up your credit score and history. Specific behaviors promote the credit rebuilding process a lot more effectively than others. Consider these factors:
On-time payments may seem like an obvious positive behavior, but stressing long-term compliance with this behavior is essential to a good credit score. It's one of the largest factors in building up your credit. You can better ensure that you don't miss a payment deadline by setting up an automatic reminder on your phone, whether through a text, email or app reminder. Alternatively, you can set up an automatic payment system.
Potential credit card companies want to see that you can use credit responsibly. Not using the credit card at all does little to create a credit history. You should aim for credit activity on your card in every billing cycle. Every instance of credit card use triggers a report from credit card companies to credit bureaus of your responsible behavior.
Credit utilization, which is how much of your credit limit you are using at a given time, factors into your credit score. Credit card companies become nervous if they see you use too much of your available credit, because it indicates a higher debt-to-income ratio — that you are taking on too much debt in comparison with your income. If your credit limit is $500, limit your credit card charges to no more than 50 percent, or $250, for each billing cycle.
Credit card companies also want to see that you've managed your finances responsibly enough to be able to pay off your balances. Make sure you demonstrate your responsible behavior by paying off your balance in each billing statement.
How a Secured Credit Card Compares to a Debit Card & Prepaid Credit Card
Confused about the differences between a secured credit card, debit card and prepaid credit card? A debit card links directly to your checking account at a bank or financial institution. When you pay for something with your debit card, the funds are withdrawn directly from your checking account. A debit card acts very much like a regular paper check, except that the transaction process occurs much faster.
A prepaid credit card is not linked to a checking account. It is a consumer account through which you make an advanced payment. The money you have prepaid, or "loaded" onto your card, equals the amount you can use to pay for purchases. Once you use up the loaded amount, you must reload the card with more funds to continue using it.
Using a secured credit card may feel the same as using a debit card or a prepaid credit card, but it is fundamentally different. Unlike a prepaid credit card or a debit card, a secured credit card constitutes a loan. Every time you use the card, you are borrowing money.
| Characteristic/ Feature | Secured Credit Card | Debit Card | Prepaid Credit Card |
|---|---|---|---|
| Available Funds | Tied to credit limit/savings deposit amount | Checking deposit amount | "Loaded" or prepaid amount |
| Reporting to Credit Bureau | Some cards report activity to at least one bureau | No reporting | No reporting |
| Budgeting | Cannot spend more than credit limit per billing cycle | Possible to overdraft on deposit amount | Strict, limited to amount user loads onto card |
| Consumer protection | Maximum liability for fraudulent charges, stolen card is $50 | May be liable for all of fraudulent charge, max out account balance | No consumer protections |
| Rewards and Benefits | Rewards and benefits programs readily available | Typically not available | Typically not available |
| Reporting of Fees | Standardized, easier for consumer to compare | Not standardized | Not standardized |
Credit Bureau Reporting
Many secured credit cards can help you establish credit history because your card activity is reported to the credit bureaus that produce your credit score. Debit cards and prepaid credit card activity is not reported.
Budgeting Tool
From a practical standpoint, all three card types can be useful as budgeting tools. All three cards limit, in varying degrees, the amount you can spend, by pegging your monthly spending to a specific dollar amount—a credit limit, checking account or prepaid amount. Keep in mind that with a debit card, it is possible to spend more than what's available in your checking account with an overdraft. When you overdraft on your account, your bank charges an overdraft fee, as high as $35.
Consumer Protections
Secured credit cards benefit greatly from consumer protections of the Credit CARD Act of 2009, which generally does not apply to debit or prepaid cards. With secured credit cards, the maximum permissible loss you can suffer from a stolen or lost credit card, or fraudulent charges, is $50. Your secured credit card company is legally obligated to investigate a suspicious charge if you submit a written request within 60 days of the activity. You'll also find that secured credit cards generally offer more protection with consumer purchases. If for example you purchase a large-ticket item, like a washing machine or refrigerator, you'll have better luck returning or seeking compensation from the merchant that sold the item.
Consumer protections for debit cards and prepaid cards are limited. For debit cards, your liability for a fraudulent charge can max out your account balance if you don't report it early enough. For users of prepaid cards, as it stands now no consumer protections currently exist.
Rewards and Benefits
You'll find it much easier to earn points through a secured credit card rewards program. Many of these programs operate under the same or similar programs found with unsecured credit cards. You'll also find other benefits available, such as travel insurance or extended warranties on purchases. Debit cards and prepaid credit cards do not typically sport rewards programs or fringe benefits like insurance and warranties.
Reporting of Fees
Secured credit cards further benefit from consumer protection legislation like the CARD Act and Dodd-Frank Act of 2010. Card companies must follow standardized reporting of fees that promote informed understanding of the costs of the credit card. Information about interest rates, changes in rates and other fees must be made clear to consumers. Generally, these legislative protections do not apply to prepaid cards. Individual debit and prepaid card companies have the flexibility to present information differently — in a manner they see fit.