The Pros And Cons Of Secured Credit Cards
The Logic of Money
JANUARY 27, 2020
Secured credit cards are great for young people who need to establish credit and those who need to rebuild credit. It can be tough to show the credit card companies that you can be a trusted customer, and that’s where the secured card comes in handy. All it takes is a little shopping and research for you to find the one card that is the right fit for you.
What is a Secured Credit Card?
First, what makes a secured credit card...well, secured? To drill it down, a secured card is different than what others consider a “regular” credit card (aka all the offers you receive in the mail or see on TV). This is due to the deposit required to obtain approval for a secured card. That deposit then serves as collateral for all of your purchases.
With a secured credit card, you can charge purchases such as a tank of gas, dinner, or groceries up to a specific amount. Typically, your credit limit on a secured credit card equals the amount of your security deposit. This prevents you from spending money that you may not have.
The larger the credit limit, the more that you need to put in your deposit, and the higher the expectation is that you will pay the bill.
Let’s say you forget to pay a bill. Then, the secured credit card company gets to keep that deposit along with charging you interest. For most secured cards, the average interest rate is around 20 percent.
On the other hand, you pay your bill on time, the credit card company will return your funds after a certain number of months or when you’re done with the card and have graduated to an unsecured credit card.
Pros of Using a Secured Credit Card
Here are five advantages of using a secured credit card to either build or rebuild your credit:
Compared to subprime unsecured credit cards, secured credit cards are considered a cheaper option, and this is due to risk. Subprime credit cards take a chance on people with bad credit, and since there is a high risk of non-payment, the subprime customers tend to charge higher interest rates and fees.
Also, credit card companies can charge one time fees like an application or processing fee. Some cards may charge a monthly fee in addition to the annual percentage rate.
The distinct difference for most secured credit cards is that they only charge their customers a yearly fee ranging from zero to $50 with no processing or monthly fees - and that’s all.
Check out Discover, Citi, and Capital One as these companies typically do not charge an annual fee to their customers. By going this route, you only need to worry about putting down a deposit that you will get back when you close the account.
One of the struggles when applying for traditional cards is that it can be difficult to get approved without previous credit history. By using a secured credit card, you have a chance to get your foot in the door no matter your credit score or history.
It’s an extra perk if you’re able to earn interest on your deposit. Look for that key benefit when deciding which type of secured credit card you plan to use. Every little bit can help in the long run.
Graduate To An Unsecured Credit Card
After a little time has passed, it is possible to graduate from your secured card to an unsecured card with the same company. There are a few companies that offer a secured credit card with a cashback program and they provide free access to your FICO score.
A great example of this is Discover, who will offer these services and then, after several months of paying your bill on time, will return your deposit and graduate you to an unsecured card.
With a regular credit card, you face the collections agencies if you fail to make a payment and you can ruin your credit score. The same is not true with a secured card. If you fail to make a payment, you simply lose your deposit, and there is no need to send you to collections.
Cons of Using a Secured Credit Card
Not everything is perfect with a secured credit card, however. Here are five reasons why a secured card may not be the best option for you.
It’s Rarely Free
Choose your card carefully. Some secured credit cards can come with a high Annual Percentage Rate or annual fees. Read the terms closely and carefully select a card that allows you to grow your credit score but doesn’t cost you an arm and a leg.
Finding the extra money needed for the card’s deposit might be tough. If you’re trying to get a secured credit card, there is a high chance your budget is already tight.
If this is the case, shop around. Try to find a card that offers to break down that payment into chunks so you can meet this requirement while staying in budget. Or find a card that only requires the least amount for a down payment so you can begin using it immediately.
The only way to increase your credit limit, giving you the ability to spend more, is to increase your deposit. While you control the amount available for you to spend, you also are limited to that amount. Dealing with a smaller limit is one of the reasons that after a few months of making on time payments, users want to move from a secured credit card to an unsecured credit card.
Depending on your card and provider, you may actually have a higher interest rate than an unsecured card. It is essential to pay off your balance in full each month and not carry any balance to the next month.
Lack of Upgrade Options
Read the fine print before you sign up for your secured credit card - not all cards are created equal. While some cards allow you to upgrade to an unsecured card with little trouble, not every credit card company works this way.
Save yourself the hassle of going through the application process again. When you’re ready for a regular credit card, find a company that will make your transition easy and stress free.
Who Should Use a Secured Credit Card?
If you are new to building credit, secured credit cards allow you to learn about having a credit card before running up a large balance. If you find one with no fee or a low APR, they are a great budgeting tool for anyone to use while improving their credit history.
You might only choose to use a secured credit card for a year so you can build up your credit score. Then you could close it once you have established responsible credit habits and can handle an unsecured card.
Some cards offer generous perks while you build or rebuild your credit. So ideally, select a card that not only returns your deposit but also reports your activity to the credit reporting agencies.
Rebuilding or building your credit is not a race - it’s a marathon. By selecting a secured credit card, you are taking that first step toward a better financial future, and it does not matter to the credit bureaus if your card is secured or not.
Keep track of your spending and make sure to pay your bill on time. Any late payments will appear on your credit report. So, set a reminder and get that bill paid on time, and you’ll improve your credit score quickly.
Make sure to gauge both the pros and cons of using a secured credit card before choosing the best one that fits your needs.