Secured Credit Cards: A Path to Better Scores

John Linfield, Executive Director of the nonprofit Institute of Financial Literacy, recalls a former client, Steve, who was dealt a significant blow to his finances that resulted in a bankruptcy filing after a divorce.

Steve’s circumstances began to improve after he obtained a secured credit card with a $1,500 limit from a major financial institution. After six months, he transitioned from the secured card to a traditional credit card. It ultimately led to Steve “preparing to put a down payment on a house,” Linfield says.

Steve’s case is an example of how a secured credit card – which Linfield describes as a hybrid between a debit card and a standard credit card – can help someone regain their financial footing and rebuild a credit history.

Linfield warns that a secured card is by no means a “magic cure” for bad credit, but with responsible use, you can use it to establish a positive credit history and build your credit scores.

The what and how of secured cards

People with a credit history marred by late payments or other black marks might find it hard to get an unsecured credit card, so a secured card is one possible route to building a positive credit history. The “secured” designation indicates that the consumer must offer a security deposit in order to get the card. Typically, the money you deposit as collateral will also be the credit limit for the secured card, Linfield says. For instance, if you deposit $500, you will probably have a $500 limit.

“It’s simply like operating a regular credit card,” he says. “The difference is if you don’t pay that balance off, the bank can turn around and take the money the card is secured with.”

The exact amount deposited varies depending on both the consumer and the bank, taking into account how much the consumer decides to set aside and what options the bank offers. Linfield recalls the lowest secured card deposit he has seen was $200, and the highest was $5,000. Some financial institutions will let you earn interest on your security deposit.

Secured cards can have higher annual fees and interest rates than regular credit cards. As Linfield explains, a secured card will typically have an annual fee, which can range from $25 to $50, depending on the bank. The interest rate, depending on the consumer’s credit history and the bank, could be anywhere from 10 to 25 percent, although Linfield says most secured credit cards have rates in the 15 to 20 percent range.

How a secured card can affect your credit

Simply going out and getting a secured card “has little or no effect” on your credit reports and credit scores, Linfield says. It is how you use it that makes all the difference. For example, if you overdraw or miss payments, “that’s going to have just as negative an impact on your credit score as doing those things with a traditional credit card,” he says.

If you make payments on time every month and begin to establish a positive payment history, you can slowly boost your credit scores. Typically, banks will report payment activity from the secured credit card to the three major credit bureaus – TransUnion, Equifax and Experian. To be certain your payment history is reported, you should ask your cardholder if it reports to credit bureau or bureaus and the frequency.

After you have established six to 12 months of positive credit history, most financial institutions will consider you ready to transition to an “entry-level” unsecured card, Linfield explains.

After the secured cardholder establishes a positive payment track record, some banks might offer to increase the credit limit on the secured card beyond what the consumer has deposited. Linfield stresses that just because the bank offers to increase your credit limit does not mean you have to accept.

“It should not be a goal to get a credit limit that is much, much higher than you actually need,” he says. “You always want to be sure, especially as you’re rebuilding credit, that you only buy the things that you can afford to pay off at the end of the month.

“It can work very, very well,” he says. “But for every one of those stories, there are two stories about people mismanaging secured cards. It was just another black mark on their credit report. It’s not as much about the product as much as it’s about the behavior of the consumer.”

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