In a lot of ways, secured credit cards sound like a raw deal. But if you have poor credit, secured credit cards might be your ticket to a great credit score.
Basically, secured credit cards—typically for people with bad credit—require you to pay a deposit that is equal to or greater than the limit before the card will be activated. Then, you can use the account as you would any other credit card. You would also pay the bill, just like you would any other credit card.
So, let’s imagine that you have a secured credit card with a limit of $500. Just to open the account, you would need to make a deposit of $500. Subsequently, you might charge $200 worth of stuff to the card.
Will the secured credit card company automatically apply the deposit to your balance? Nope—you need to pay the $200 bill, just as you would any other credit card. If you make payments, the balance will incur interest. And if you miss payments, the late payments will be reported to the credit-scoring bureaus, and your credit score will suffer, just as with a traditional (unsecured) credit card.
All the while, the bank holds onto your deposit. If you eventually default, the credit card company will keep your deposit, but only after they have turned you over to a collection agency and attempted to collect payment from you.
In short, secured credit cards require you to pay now, buy later, and then pay again, whereas traditional credit cards allow you to buy now, pay later.
If you make payments on time and learn how to build credit, you can eventually request that the secured credit card be transferred to a traditional credit card, at which point the bank will refund your deposit. The deposit will also be refunded if you close the credit card account, so long as you have no balance at the time.
Though secured credit cards might not seem like that great of a deal, they are necessary for two reasons. First, people with bad credit often cannot qualify for traditional credit cards, so secured credit cards allow them to build their credit scores (in this way, they are much like authorized users). Second, many businesses require that their customers have credit cards. For instance, most cell phone companies won’t give you a phone without a credit card—secured or otherwise.
As I mentioned, if you pay the bill on time and keep your utilization rate (the percentage of the balance held against the limit) under 30 percent, then a secured credit card will help your credit score just like any other credit card would. And as your credit card score begins to improve, you can contact the credit card company and ask if it can switch the card to unsecured.
While secured credit cards have high interest rates and force you to set aside a sizable amount of money as a deposit, they are an attractive way to rebuild your credit. Use them in the right way—with careful purchases and repaying your debt on time—and you’ll soon be back in the good graces of your credit card company.