How Does a Secured Credit Card Work?

Building credit from scratch is often referred to as a chicken-or-the-egg problem. If you don’t have a credit history, it can be challenging to get approved for a credit card. But if you don’t have a credit card, it’s hard to build a credit history.

Here’s where secured credit cards can save the day. It’s possible to be turned down for a secured credit card, but if you’re approved for one, it’s a good way to get started on your journey to great credit.

We’ll start with the basics and work our way up to the advantages — and disadvantages — of secured credit cards.

Up ahead:

— Definition of a secured credit card.

— How secured credit cards work.

— Do secured cards build credit?

— Pros and cons of secured credit cards.

[Read: Best Starter Credit Cards.]

Definition of a Secured Credit Card

There are both unsecured and secured credit cards. An unsecured credit card doesn’t require a deposit to get approved for the card. The top unsecured credit cards from major issuers are typically used by those who have at least fair credit. There are some unsecured credit cards available for those with zero or bad credit, but they tend to have high interest rates and fees.

Due to the cost of unsecured cards that target those with little or bad credit, many turn to secured credit cards. Secured credit cards do require a deposit, usually ranging from $200 to several thousand dollars, depending on the deposit requirements of the issuer.

The deposit stays in an account, and the purpose of the deposit is to decrease the risk for the lender. If you don’t pay for the purchases you made with your secured credit card, the financial institution will use your deposit to pay it off.

How Secured Credit Cards Work

When you get approved for a secured credit card, you’ll receive a credit card that looks just like an unsecured credit card. There’s no visible clue that the card is secured.

The amount of your security deposit is usually equal to the credit limit for your new secured card. You’ll use your secured credit card just like you would an unsecured card. You can use it for purchases everywhere that accepts your secured credit card.

Just to be clear, your security deposit stays in an account with the issuer. You’ll make payments on your balance from one of your own bank accounts. So, you’re actually buying things on credit.

[Read: Best Credit Cards for Bad Credit.]

Do Secured Cards Build Credit?

Most secured credit card issuers report your payment history to the three major credit bureaus: Equifax, TransUnion and Experian. If you can’t find confirmation on the card’s home page that payment history is reported, call the issuer to make sure it’s the policy.

When your secured card’s bill comes, you must pay the bill by the due date. If you pay your balance in full, you’ll avoid paying compound interest. If you consistently make on-time payments and keep low balances on your card during the month, your credit score will begin to increase.

Pros and Cons of Secured Credit Cards

Secured credit cards have many advantages, but there are also downsides to this type of credit card.

Pros:

— Secured credit cards help you build credit and develop a good credit score.

— Secured cards help you learn how credit works. And since the credit limits are on the low side, it helps to minimize your risk of getting into debt.

— Some credit card issuers will promote you to an unsecured credit card. Not all secured card issuers have unsecured versions, but many of them do.

— When you’ve built a good credit history and you’re ready to upgrade to an unsecured card, you can get a refund of your deposit.

— Many secured credit cards offer rewards and benefits.

[Read: Best Credit Cards for Fair Credit.]

Cons:

— You have to make a security deposit, and this ties up your money for the life of the secured card.

— Some secured cards have many fees, so you have to read the fine print carefully.

— You’ll probably have a low credit limit, but this is often a good thing while you’re getting comfortable using credit.

— Some secured credit card issuers don’t offer unsecured versions, which means you have to apply for an unsecured card from another issuer.

I know it’s difficult to build credit or to come back from a poor credit score. A secured credit card can be a great option, but be sure you read all the disclosure statements and understand if there are fees involved. After about a year of responsible use, you’ll probably have at least a fair FICO score (580-669), which is good enough to make the leap to an unsecured credit card.

More from U.S. News

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How Does a Secured Credit Card Work? originally appeared on usnews.com

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