Here Are The Pros And Cons Of Secured Credit Cards
If your credit score is lower than you would like, a secured credit card could help you improve it.
Not only that, but a secured credit card can help you build a credit history when you're starting from scratch.
Secured credit cards are a useful credit-building tool, but they're not without downsides.
For starters, they're for people with bad credit, which means you should avoid them if your credit score is already within a healthy range.
Secured cards also have a number of potential drawbacks, including annual fees and higher interest rates.
Let's go over the pros and cons of using secured cards.
What is a secured credit card?
With a secured credit card, you make a down payment or deposit in an account when you sign up for your card—this deposit acts as collateral, making a secured card different from a regular, unsecured credit card.
If you pay your bill as agreed, you keep the deposit. But if you default, the credit card company gets your money.
On the other hand, standard, typical credit cards are "unsecured," meaning they're not backed by any collateral, such as a mortgage or car loan. With those types of accounts, the lender can take back the car or the house if you stop paying your bills.
Under many secured credit card agreements, your down payment or deposit also serves as your credit limit. For example, if you put down $500, you can only charge that much on your card.
Because secured credit cards are designed to act as a bridge to improve your credit, some secured cards allow you to convert your secured card to a regular, unsecured credit card after a certain period of time.
5 good things about secured credit cards
Secured credit cards offer a number of benefits.
If you're building or rebuilding your credit, here are five ways a secured card might help you:
1. Easier qualification process
Always remember that it takes credit to get credit.
How do you build or rebuild credit when you can't qualify for credit in the first place?
Secured credit cards are made for people with little credit or bad credit.
If you've been turned down for a credit card because you lack a credit history or your credit score is too low, a secured card could help you get your foot in the door.
2. No risk of collections
If you stop paying on a regular credit card, the credit card company will turn you over to a collection agency, which will pull down your credit score and make it difficult to qualify for future credit.
But with a secured card, your creditor simply keeps your deposit, so there's no need for them to use a debt collector.
Keep in mind, however, that any late payments will still show up on your credit report.
3. Some cards earn interest
Depending on which type of secured credit card you apply for, you could earn interest on your deposit.
Before you open a secured card, ask your lender if the account is interest-bearing. You probably won't earn a lot, but the interest can be an additional perk.
4. Establish a positive credit history
Most companies that offer secured credit cards report your on-time payments to the credit bureaus.
This shows that you're responsible, and it can make you less of a risk to future creditors.
5. Qualify for a regular credit card
You can think of a secured credit card as a sort of credit card with training wheels.
If you make your payments on time and do everything you're supposed to do, you can eventually move on to a traditional credit card.
As time passes and you establish a positive credit history, you can qualify for larger credit limits and better interest rates.
5 downsides to using a secured credit card
Unfortunately, there are a few drawbacks to using a secured credit card.
Before you apply, be aware of possible downsides.
1. Coming up with the down payment
Perhaps the most obvious drawback to a secured credit card is the down payment requirement. Deposit amounts vary among lenders, with most cards only requiring a few hundred dollars down.
But some secured cards ask for $1,000 or more, and there are even higher down payment requirements out there.
If you're on a budget, it can be tough to come up with that much money up front.
Some secured card lenders give an option for splitting the deposit into payments, which can help if you're working on a tight budget.
2. Fees and costs
Not all secured credit cards are created equal, so be on the lookout for higher than average annual fees, application costs, and other fees.
Pay close attention to the card's terms and conditions to make sure you're not paying too much in various fees and costs.
3. Higher interest rates
Secured credit cards are designed for high-risk borrowers, so it's not uncommon for them to come with less than favorable terms.
For example, some secured cards have a higher annual percentage rate (APR) compared to unsecured credit cards.
4. Low credit limits
Most secured credit cards limit your available credit to your down payment.
If you pay $300 up front, for example, you can only charge a maximum of $300 on your card.
This is why most people aim to upgrade to a regular credit card once they've established a positive payment history.
5. No upgrade option
This particular downside won't apply to all secured cards, so you can avoid it by shopping around.
With some secured credit cards, the lender gives you the option to transition to a regular credit card after a certain amount of time.
But not all lenders offer this.
If your card doesn't include an upgrade option, you'll have to go through the application and qualification process all over again when you're ready to move to a standard credit card.
How to use a secured credit card effectively
The purpose of a secured credit card is to show future creditors and lenders that you're a low credit risk.
To do this, it's important to use your secured card effectively.
Secured credit cards vs. prepaid debit cards
If you're in the market for a secured credit card, you might wonder how a secured card compares to a prepaid debit card. At first glance, these two products can seem like the same thing.
But a prepaid debit card is different from a secured card.
With a prepaid card, you load the card with your own funds up front, which means the lender doesn't extend any credit—nor does it report payments to the credit bureaus.
When you're trying to establish or rebuild credit, a secured credit card is usually the better option.
Should you get a secured credit card?
If you're new to credit, or you're trying to recover from bad credit history, a secured credit card can help.
As long as you make your payments on time and use your card responsibly, you should be able to improve your credit score within a relatively short period of time.
Most borrowers see an improvement within a few months, and it's usually possible to upgrade to a regular credit card after about a year.
About the Author
Mike is a recognized credit expert and founder of Credit Takeoff. His credit advice has been featured in Investopedia, CreditCards.com, Bankrate, Huffpost, The Simple Dollar, Reader's Digest, LendingTree, and Quickbooks. Read more.