Bad Credit? – Time to Look into a Secure Credit Card

I’ve never heard of a Secure Credit Card before…What is it and how does it work?

I recently had a friend go through the process of rebuilding her credit after a 5-year battle with recovering from Identify Theft…not fun! Not only can this turn your financial world upside down, it can really mess with your credit score thereby ruining your chances of obtaining credibility when seeking to apply for a loan, mortgage, car lease, or credit card, amongst other things that can impact you negatively.

She came to me for help to and while brainstorming ideas on how to rebuild that credit, I came across the concept of a “Secured” Credit Card. What is that you ask? In short, a secured card can be viewed as a credit building tool that simply requires you to make a cash deposit to the card lender, which in turn is backed by that deposit and usually becomes the max limit of the card.

For example, if you deposit $300 to secure the card, you’ll have a $300 max line of credit for that card.

That deposit reduces the risk to the issuer, which makes it more viable as an option to obtain vs. a traditional aka “unsecured” credit card, which would be far more difficult to qualify for someone with low/bad credit and a limited credit history.

If you don’t pay your bill with this type of card, the card issuer can withdraw the funds from the deposit you initially paid to open the card. This is the reason this type of card is a good option for people with poor credit as it helps to establish, strengthen, and rebuild that credit while giving the issuer some peace of mind that the money loaned is “secured” or guaranteed against the deposit as collateral. The deposit acts like insurance for the lender if the cardholder fails to make their on-time payments.

Secured cards will vary in its own minimum and maximum credit limits. They typically start at a minimum required opening deposit of a few hundred dollars and go up to several thousand dollars, which depends on the card limit and how big of a deposit you’re willing to make upfront.

Unsecured “Traditional” Cards vs. Secured Cards

There are two types of credit cards: Unsecured vs. Secured. Eligibility depends on how good your credit is.

Unsecured “Traditional” Card

An unsecured card does not require a deposit and poses a higher risk to the card issuer. Credit card companies typically require a minimum average credit score. However, to qualify for the best unsecured cards with the lower fees and rates, there is preference to having excellent credit which usually grants better rewards programs, cash back, miles and/or points on everyday purchases.

You should be aware that some card issuers may target specific unsecured cards for those with low/damaged credit with “easy qualifications” but these cards are almost guaranteed to have unfavorable terms including annual fees, extremely high APR & interest rates, limited rewards programs, and hidden penalties. If this were the case, I’d recommend applying for a secured card rather than a high-fee unsecured traditional card.

Secured Card

Secured cards are issued by most well-known major banks and credit card companies and typically viewed as a financial credit establishing tool to either boost or build your credit. In short, a secured card requires a “security” deposit to the lender, hence the name, which in turn sets the credit limit equal to the deposit given.

As such, secured cards are the targeted alternative for those who are needing to build credit but can’t get approval for an unsecured card. Maintaining on-time and consistent payments for everyday expenses that you can repay immediately toward a secured card can build your reputation with the lender to allow for increase in limit or even upgrade to an unsecured credit card with better terms and rewards. 

Building good credit takes time. If you’ve never owned a credit card before (i.e. college students), have a poor/damaged credit history (i.e. bad spending habits, rebuilding after identity theft, etc..) or just want to improve your credit score, a secured card might be a good option for a brighter financial future.

A responsible user of the card will eventually qualify to get their secure deposit back with the added benefit of having improved their credit score simultaneously, which could now improve your chances of obtaining a normal unsecured credit card with higher credit limit and ultimately no deposit required. Awesome!

Since every lender is different, you’ll need to check the terms of the card provider you are applying for to ensure their terms are acceptable. The secured deposit amount may vary between issuers, usually between $50 – $300+. Some of the more Notable Secured Credit cards will allow you to increase your limit in as little as six month or upgrade your account directly from a secured card to an unsecured “traditional” card while others may not. If they do not give you that option to upgrade and you elect to close the card, the issuer will return the deposit funds and you can apply elsewhere for a regular credit card as your credit should have hopefully improved by that point.

So…What’s the catch?

It’s important to remember credit cards of any sort do come at a cost, most literally in the form of fees and interest to the card issuer, especially when balances go unpaid.

Since an unsecured card is easier to obtain, it poses a higher risk to the lender which usually means high fees. It’s ironic to say, but the better your credit score is at the time you are applying for this type of card, the better! However, some cards target those with especially poor credit, and these tend to have some extreme high fees. While you may have no choice but to go with a high fee secured card, pay particular attention to these when you use them and be sure to pay them off so you avoid accruing interest!

Best practice, especially with building your credit with any type of card, is to spend within your net income and stick to an established budget!

6 Tips for Responsibly & Effectively Using Your Secured Card:

1. Shop around before applying for a secured card. Things to keep in mind when making your decision include:
   1. Fees
   1. Interest rate
   1. Required security deposit – Be sure to fund your account within the timeframe allotted by the card issuer or you may forfeit the card and have the account closed.

• Avoid excessive spending, aka – create a budget and stick to it! Keep an eye on your spending and only purchase things you need and can pay off immediately. Spending should be done sparingly. The point here is to avoid paying unnecessary interest charges which can eventually exceed your initial security deposit if you aren’t careful.
  • If you aren’t sure how to budget, take a look at the article here:

Budgeting Basics – KEEP IT SIMPLE!

• Take advantage of payment alerts so you don’t miss a payment. Even one missed payment can negatively impact your credit which may already be fragile if the intent is to use the card to rebuild your score.

• Setup automatic payments to avoid the late fees and interest charges

• When your budget allows, always try to contribute more than the minimum monthly payment owed before the due date. Whenever possible, you can even make additional payments in the same month. The goal is to avoid interest charges by paying in full as rates are generally higher on secured cards.

• Consistently monitor your credit score over time. When there has been a meaningful improvement, reach out to your issuer about upgrading to an unsecured card. This may take time to attain, but be patient, it will happen!

The fact is, when you are in the unfortunate position of having bad credit, simply relying on prepaid/debit cards and cash for purchases will do nothing to rebuild that credit since the activity isn’t reported to the major credit agencies, which include: Equifax, Experian, and TransUnion. On the flip side, if you use a secured credit card, you can begin to reestablish a positive credit history which can be built over time, if handled properly, to show that you are a responsible consumer who can use credit wisely.

Who should consider a secured card?

A secure credit card is perfectly geared toward someone with low to no credit history and/or poor credit score as it should be considered a first step to begin building your credit profile. If you do not qualify for a traditional unsecured credit card or other loan, you may qualify for a secured credit as they are designed for those with limited to no credit or those with damaged credit.

How do I get a secured card?

1.) Apply for a Secured Card:

You’ll first need to apply for the card with a lender and submit an application like any other credit card request. A secured card will typically require you provide your bank account and routing number to process the refundable security deposit required. Remember, this deposit amount becomes your maximum credit limit for charges on the card. 

2.) Make Your Security Deposit

The amount you pay towards your initial security deposit can vary, but it typically equates to the same amount as your max credit line.

• For example, a $200 deposit might give you a $200 credit limit.

You may find a card that provides a credit line higher than the amount of the security deposit, which is usually based on your credit history. In addition, if you deposit more money before the account is opened, you may be able to get a higher limit.

• Capital One’s secured card could require only a $49 or $99 security deposit for an initial $200 credit line.

While many card issuers require funding of the deposit upfront, some card issuers may allow funding of your deposit over a period of time for added flexibility.

How to Use your Secure Card

After approval and funding of your security deposit, your secure card will be issued for use. Once received, like a traditional unsecured card, you can use your new secured card for everyday purchases both in person and online. The card should look aesthetically like any other traditional credit card so no one should be able to tell the difference from appearance if that is something you are conscious of.

However, what you should be conscious of to keep in mind is your card is secured by the collateral of your deposit and therefore your intent should be to pay your balance in full every month. This includes keeping track of your spending, reviewing your monthly statement charges, and paying on time every month to limit interest charges.

If you decide to cancel the card after a period of time, deposits are usually refundable pending your balance is paid off in full, however, check with your card issuer for their specific policies about when and how refunds are distributed.

Why can’t I just use a prepaid debit card instead of a Secured card… What’s the difference?

Secured Credit Cards vs. Prepaid Cards & Debit Cards

While using secured cards my seem similar to the workings of a prepaid or debit card stamped with a MasterCard, VISA, or American Express logo, they are inherently different in one key aspect.

Secure credit cards help build your credit!

As per the Consumer Financial Protection Bureau (CFPB), since prepaid cards and debit card do not extend any actual credit borrowed from the card issuer since you are essentially using your own preloaded money for purchases or linking direct to your checking account, activity on these types of cards isn’t typically reported to the major credit bureaus: Equifax, Transunion and Experian.

• Prepaid Cards – Loaded with funds ahead of use. Activity not typically tracked by major credit agencies to credit building.

• Debt Cards – Linked to checking account. Activity not typically tracked by major credit agencies to credit building.

• Secured Cards – Credit card company provides funding for the transaction that you then pay back each month. Utilization and payment activity tracked by major credit bureaus for credit score reporting.

In addition, prepaid & debit cards usually lack security features and can also have fees that secured credit cards do not.

If your goal is to build credit and establish a credit history, a secured card is the better choice.

How to Improve Your Credit Quickly While Using Your Secure Card

If your goal in obtaining a secured card was to build or rebuild your credit, you’ll find some solace in that many people usually see results in about a year of responsible use to drastically improve their credit score to the point of applying for a traditional unsecured card.

However, the key to accomplishing this isn’t rocket science but entails you being able to make on-time payments while maintaining a debt-to-credit ratio of 30% or less!

Did you know that 35% of your total credit score is made up of accounting for your on-time payments? This is crucial to building your credit profile as the secure cards that are cream of the crop will report your payments and usage to all 3 of the major credit reporting bureaus: Equifax, Transunion and Experian. This will eventually help you to upgrade your credit qualifications for potential approval of an unsecured card and other loan types, but only if you end up on the good end of the credit line.

The second part to the equation is your credit utilization, also known as your debt-to-credit ratio. This is the ratio of your total outstanding balance on your card to your overall credit card limit and accounts for another 30% of your total credit score. You want to use your card but don’t want to max it out if it can be avoided. Ideally, you want to maintain a ratio at 30% or less.

The higher the limit the easier it is to maintain a low credit utilization below 30%. This shows you have consistent yet responsible use of the card. However, this can be tricky if you are using a secure card with a low limit.

• High limit $5,000 unsecured card: 30% of $5,000 limit = $1,500 ideal monthly balance to maintain 30% utilization.
  • Low limit $300 secured card: 30% of $300 limit = $90 ideal monthly balance to maintain 30% utilization.

As you can see you have less wiggle room with a lower limit to maintain the utilization ratio, but it is possible if you pay off your balance as soon as you are able, especially if it is before the billing cycle competes as it helps to keep the credit utilization low.

This is how my friend was able to finally dig herself out of her lackluster credit and improve her score by almost 180 points in a year. It did take some mental preparation and determination to monitor her spending to stick to a budget and keep on top of her payments.

As a bonus along the credit building journey with your secured card, typically when card issuers see consistent progression and improvement of your credit score over time, you may qualify to “graduate” or transfer your secured line of credit to an unsecured card. The process may even involve returning your deposit. This helps your credit as there aren’t any hard inquires placed on your account to affect your score when transferring the account as you aren’t opening a new account. Be sure to check with your credit card company to confirm what is possible and how your account will be handled during and after the transition to a traditional card as well as any impact on your credit.

As cliché as it may seem, remember that improving your credit score is a process that should be a marathon not a sprint… it doesn’t just happen overnight and takes time to improve and maintain. A secured card is just one tool in your arsenal to making that goal a reality. The real reward is having a great credit score that will help open doors for your financial future when it comes to saving money and qualifying for major life event purchases, which is well worth the effort!