What is a secured card and how do they work?

Secured cards are ideal for the consumer with credit that’s not its best or someone new to credit. Because of this, bank issuers have certain systems in place to make sure their investment is protected. Here is what a secured card is and how it works:

What is a secured card?

A secured card is a credit card designed for a consumer with bad credit or a thin credit file.

They require you to pay a refundable deposit, which secures your available credit. Because having a credit card is the easiest and fastest way to build credit, a secured card can be worth your while.

How do secured cards work?

  1. What it is. A secured card is a credit card that requires a refundable deposit in exchange for a credit limit, typically $200 or more. Most credit cards are unsecured credit cards, which means a security deposit isn’t required.
  2. What to watch for. Even if a secured card has no annual fee, you’ll need to check for other kinds of fees, including late fees and returned payment fees.
  3. How to get approved. Check your credit score and the bank’s requirements to make sure you are likely to be approved.
  4. What to do first. If you are approved, you’ll be required to pay the refundable deposit. Then, you’ll be approved for a credit limit, typically starting at $200.
  5. How to use it. Even if your credit limit is $500, that doesn’t mean you should spend it. If you carry a balance of $250, that means your utilization ratio is 50% — you want your ratio to be as close to zero as possible, for credit-building purposes. Also, you need to pay on time each month, again to ensure you are building your credit.
  6. Rinse and repeat. Check your credit score after several months and see if you qualify for a better card. Some cards, such as the Capital One Secured Mastercard, increase your credit limit after several months of on-time payments. For good measure, check your credit reports, as well, looking for errors or mistakes that need to be corrected.

How do you use a secured card?

You can use a secured credit card in the same way you use an unsecured card – simply present the card to the retailer to make a purchase, provided the merchant accepts the network displayed on the front of your card (Visa, Mastercard, American Express or Discover).

You can use the card for all manner of purchases; to rent a car or hotel room; or even, in some cases, for rewards. This is perfect for traveling you need to do in 2019.

However, because the credit limit is typically only several hundred dollars, it’s worth your while to limit use of the card to one or two small purchases a month, then pay off the bill in full before the due date.

This will allow you to build your credit more effectively by keeping your balance low compared to your available credit, called your utilization ratio.

Because you don’t know exactly when during the month that the card issuer will report your credit habits to the 3 credit bureaus, it’s a good idea to pay in full several times a month, keeping the utilization ratio as low as possible. Create 3 reminders each month to ensure that you pay on time and often enough.

Do secured cards really help your credit?

Secured credit cards can help your credit, if you pay in full and on time each month and you make sure the issuing bank reports your credit habits to the 3 major credit bureaus. By paying in full and on time, you are building your credit history as well as improving 65% of your score with a single action.

If you ensure that your credit habits are being reported, then you know that the credit bureaus have what they need to share with the credit score models and lenders.

Some 34% of consumers use their credit card to build credit, one of the primary reasons for having a card. Experian polled consumers to find out what were their primary ways to use their card. As you can see, building your credit is a favorite reason:

Alternatives to secured credit cards

Whether you don’t want to plunk down a security deposit or you don’t qualify for a secured card, there are a number of alternative ways to enjoy convenience, the safety of a cashless life and even credit building.

Unsecured credit cards

Usually unsecured credit cards are for consumers with better credit, but there are some available for fair and even poor credit. However, they often have hidden, weird fees. That said, there are a few that are worth a look, such as the Discover it® Student Cash Back and the Discover it® Student chrome. Both have minimal fees and both offer rewards for restaurants, gas stations and more.

Retail credit cards

Retail cards are often co-branded with a network, such as Visa or Mastercard, and they frequently only require fair credit. There is usually no security deposit required, but the APRs are typically higher than other credit cards.

Prepaid cards

While you can’t build credit with these cards, some people use them to manage their spending. Prepaid cards can be purchased at grocery and other stores, then reloaded with money when the balance runs low. Prepaid cards are safer than cash because they have some protections by federal law.

Debit cards

Debit cards are attached to your checking or savings account and can be used at points of sale and as an ATM card. You won’t be able to build credit with this kind of card, and you’ll need to check your financial institution about protections, because they don’t automatically have the protections of credit cards or prepaid cards.

Credit-builder loan

There are different types of credit-builder loans, including unsecured loans that can be used for emergencies, such as a car breakdown, and secured loans that require you to save. As the name implies, they are designed for building credit. Community banks and credit unions often offer these lending products.

Passbook loan

A passbook loan is a lending product secured by a savings account. According to Investopedia, some lenders lend up to 50% of the savings account balance while others lend up to 100%. You can earn interest on the account, including the amount borrowed.

How to improve to an unsecured card?

Unsecured cards often come in the form of a rewards card, one of the favorite types of cards for consumers. There are airline cards, general purpose products, hotel cards – all of these can deliver benefits that make upgrading your card worthwhile. By upgrading to an unsecured card, you also have access to excellent balance transfer cards, luxury cards, and other products just not available as secured cards.

So, what’s your first step? It all has to do with your determination to improve your credit, thereby improving to a better card. With on-time payments and low balances, you will improve your score in no time.

Once your credit score is in a good place (at least 700 on a scale of 300-850), it’s time to think about what to do next. Note that some cards, such as the Discover it Secured card, lets you transition to an unsecured card after a period of time, provided your payment habits are good. Check with your card issuer.

Or ask if you can trade up, allowing you to keep your secured card’s good credit history, but enjoy the benefits of an unsecured card. Heads up that you likely won’t be able to benefit from the new card as a new member, meaning you may not get such pluses as the sign-up bonus. However, you will benefit from any ongoing rewards that the new card offers.

If you don’t qualify for an upgrade or there is a disadvantage to the new card, such as an annual fee you don’t relish paying, hang up and start doing your research – it’s time to look at cards that best suit your lifestyle.

Once you find the unsecured card of your dreams, it’s time to look at whether to keep the secured card. However, only close it if there is a compelling reason, such as recurring fees that you want to break away from. Be mindful that when you close a card account, while your good payment habits don’t drop off your credit reports for 10 years, the average age of your cards will go down.

While secured cards are one of the top card types (as you can see below), we are all striving to get a rewards card or airline card, right? With a rewards card, you can earn tens of thousands of points or miles a year or hundreds of dollars back just by taking full advantage of the card’s offers. Here are the top cards consumers have in their wallets, which can give you motivation to keep working on your credit building:

How to use your secured card correctly

Now that you know how to avoid the common pitfalls of bad card management, how do you handle one correctly? It only takes 3 easy steps:

  1. Pay on time. While it takes months to build your credit with good payment habits, one or two late payments can cause a big drop in your score. And not only is paying on time good for your credit, it keeps you from having to pay late fees and even losing your card.
  2. Pay in full. In fact, pay multiple times a month to keep your utilization ratio low – because you don’t know when your issuer will send your account information to the 3 major credit bureaus. This will also help you avoid interest charges.
  3. Place a small charge on the card. Don’t forget to use the card each month. If you lose your card to inactivity, you can’t build credit month by month. Put a recurring reminder on your calendar to ensure that you don’t forget. Or better yet, place an auto debit for a small charge on your card.
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