With tighter lending restrictions these days, a lot of younger people in college and new graduates are having a hard time getting approved for credit cards or loans of any type. And because they aren’t able to access credit in the first place, it creates this cycle of not being able to improve their credit score and getting turned down for credit time after time.
This is a very common problem. In fact, I get the “how do I build credit when I don’t have any?” question almost as much as any other here at 20somethingfinance. Fortunately, there are a few ways to build your credit report and credit score – and one of them is through a secured credit card.
What is a Secured Credit Card?
Secured credit cards are commonly used as a way to build your credit and prove to creditors that you are a safe bet in the future. To understand what a secured credit card is, you first need to understand what ‘secured debt’ and ‘unsecured debt’ are.
Secured debt is debt that you back up with collateral – a possession that can be taken from you. If you do not make your payments, you may lose the possessions that you purchased via this debt and be subject to other legal action. Auto loans or mortgages are two examples of secured debt. If you do not pay off your debt, each could be taken from you to pay off your debt.
Unsecured debt is debt that has no collateral behind it. This includes all credit cards excluding secured credit cards. If you don’t pay off your debts here, you may be harassed by creditors and bill collectors the rest of your life, but they have little power other than ruining your ability to receive secured debt at good rates in the future. It is hard to get approved for unsecured debt if you have no credit history or have a bad credit score because of this reason. And it’s for that very same reason why those with poor credit scores are usually charged higher rates – because they are higher risk.
Back to secured credit cards.
How do Secured Credit Cards Work?
In the case of secured credit cards, your collateral is your cash. Much like a debit card or checking account, you must deposit funds into a secured credit card account. If you do not pay your bills, those funds can be taken from you to pay off the balance. The amount that you deposit becomes your credit line for the secured card. Other than that, there is no big difference between an unsecured credit card and a secured one. They can be used in the same way, and they have the same Visa or MasterCard logos.
Because you have backed up your purchases with collateral, secured credit cards are extremely easy to obtain and get approved for so that you can build your credit. Most secured credit cards will report your activity to the three credit bureaus on a monthly basis.
Another interesting thing to note about secured credit cards is that most offer interest on your collateral. It’s usually a nominal amount, similar to what you might get for a savings account, but better than nothing!
What is the Difference Between a Secured Credit Card and a Debit Card?
The difference between a secured credit card and a debit card is that funds are not deducted from your cash deposits with secured credit cards like they are with debit cards. Just like with unsecured credit cards, you must pay off a monthly balance and interest could be charged if you do not. This is not the case with debit cards. Also, you cannot build a credit history with a debit card – a key differentiator.
You will not be debited simply for missing one or two payments. Usually the deposit is only used as an offset when the account is closed, either at the request of the customer or due to severe delinquency (150 to 180 days).
How to Use a Secured Credit Card
Secured credit cards are still credit cards. And because of that, they are inherently dangerous to use because of the high interest rates involved. Remember, the point of a secured credit card is to build your credit – not encourage irresponsible purchasing behavior.
As with all credit cards, you should pay your balance in full every month so as to not incur any interest charges. And use your credit card as you would your cash. Don’t let the ease of the swipe negatively influence your spending habits.
Comparing Secure Credit Cards
When shopping for a secured credit card, here are a few guidelines to follow:
- Shop around. There is a wide variety of cards, and you should only get one from a reputable issuer. There are a number of shady secure credit card issuers out there that pray on those with poor or no credit, so be careful.
- Many secured cards charge an annual fee, but increasingly more do not.
- You should never be charged interest if you are using your card appropriately, but you should still shop around for a reasonable APR that compares to unsecured credit cards.
- You should not have to sign up for any additional services or fees.
Secured Card Discussion:
- Have you used one to build your credit?
- What other tips do you have for building credit when you don’t have any credit or have poor credit?