What are secured credit cards?

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In a Nutshell

A secured credit card can be an effective way to build credit. Secured cards have much in common with unsecured credit cards — the main difference is that you’ll have to make a security deposit to open an account. The deposit acts as collateral and usually sets your credit limit, too.
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When you can’t qualify for an unsecured credit card due to having negative credit history or little to no credit history, a secured credit card could be a good way to go.

Unlike unsecured credit cards, secured cards require a security deposit to open the account and set the credit limit. But if you pay your bill on time and in full each month, you might build your credit enough to graduate to an unsecured credit card.

Let’s take a closer look at how secured credit cards work and when they might be right for you.

How a secured credit card works

A secured credit card isn’t totally different from other types of credit cards — you can use it to make purchases up to your preset limit just like you would with any other credit card. And you still have to pay your bill on a regular schedule.

What sets secured cards apart is that you need to put down a security deposit with the card issuer to open the account if you’re approved. The deposit serves as collateral for the card issuer, which often makes secured cards easier to qualify for. And you can receive the deposit funds back if you close your account, as long as you’ve paid off your balance.

The deposit also helps determine the card’s credit limit, which is usually equal to or higher than your actual deposit amount.

Your deposit may be as low as a few hundred dollars or as high as a few thousand dollars, depending on the credit limit you request and are approved for. For example, if you make a $500 deposit, it’s likely your credit limit will be around that amount as well.

If you plan to use the card to build credit, make sure that the issuer reports your payment information to the credit bureaus. When you make on-time payments, that’s positive activity that can help build your credit history — but only if it’s reported. Regular payments might eventually improve your credit enough to help you qualify for an unsecured credit card with better terms. Some card issuers even consider you for an unsecured card automatically after a certain number of on-time payments.

But a secured credit card isn’t a guaranteed way to build credit. If you fail to make your payments in full and on time, you could end up with a negative credit history. Plus, being delinquent on your account means the card issuer may use your security deposit to pay the balance you owe.

Tips for using a secured credit card

While secured credit cards can be great, it’s important to know what you’re getting into before applying. Here are a few things to keep in mind.

  • Remember that you’ll need to have the money for your security deposit when you open your account. It might be necessary to save ahead of time to make sure you’re ready.
  • While it’s best to avoid as many card fees as you can, some secured cards charge more fees than others. Some of the fees you’ll see include application fees, set-up fees and annual fees. These fees may not count towards your security deposit.
  • Depending on the card and the size of your deposit, your credit limit may be on the lower side. So before you apply, consider how you’ll be able to use your secured card.
  • Once you’ve built up your credit, you may be able to qualify for a higher credit limit, or even an unsecured card. But not all issuers consider you for these offers automatically, so it’s best to track your credit scores and reports regularly to get a sense of when it might be time to try graduating to an unsecured card.

About the author: Sean Cooper bought his first house when he was just 27 and paid off his mortgage at 30 in 3 years. An in-demand personal finance journalist, money coach and speaker, his articles have been featured in publications suc… Read more.