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Secured credit cards are often used to build good credit from scratch. If you have a non-existent credit history or a low credit score, these tools can be life-changing. But how exactly do they work, and how do you get one?
In this article, we explore the ins and outs of secured credit cards and outline their features, benefits, and how to use them to effectively rebuild your credit.
If you’re ready to build your credit and work towards your financial goals, read on!
How Do Secured Credit Cards Work?
To get a secured credit card, you need to make a security deposit. This deposit acts as collateral for the card issuer and sets the credit limit. For example, if a user makes a $500 security deposit, they will have a $500 credit limit on their secured credit card. The deposit is refundable, usually after a certain period of responsible credit card usage or when the cardholder decides to close the account. This allows users to make purchases and build credit just like with a regular “unsecured” credit card.
Secured credit cards are ideal for cardholders who want to build credit but cannot access a traditional “unsecured” credit card because of a poor credit history or lower credit score. You can use a secured credit card to make purchases, pay bills and withdraw cash. All the transactions made with a secured credit card are reported to the credit bureaus, allowing individuals to establish or rebuild their credit history.
The difference between a secured and unsecured credit card is as follows:
| Secured Credit Card | Unsecured Credit Card |
|---|---|
| Requires a deposit. | It does not require a deposit. |
| Requires reliable enough income and a not-overly risky debt history. | Requires a good credit score and reliable credit history. |
| Improves credit score over time. | Improves credit score over time. |
| Typically lower credit limit. | Typically higher credit limit. |
| Does not come with extra rewards and benefits. | Comes with extra rewards and benefits. |
| Lower interest rates | Higher interest rates |
The Benefits Of Using A Secured Credit Card
Secured credit cards offer several benefits for individuals looking to build or rebuild their credit history:
- Inclusivity: Because secured credit cards require a security deposit, they are often available to individuals with poor or limited credit history.
- Chance to demonstrate financial responsibility: By paying back your card regularly, establishing a positive credit history, and keeping your credit utilization low you can demonstrate financial responsibility to future lenders.
- Zero liability protection: Most credit cards come with this feature. It protects the cardholder from potential fraud.
- Free Credit Monitoring: Depending on the secured credit card you get, it may offer free credit monitoring. Making it easier to monitor your progress and helping you catch issues before it’s too late.
These features can offer peace of mind to potential card users and make it easier to start the journey to a good credit score.
Which Factors Affect Your Credit Score?
Various factors contribute to your final credit score. These factors include other loans and debts, your credit utilization ratio, your payment history, and how recently you applied for a credit card.
The extent to which each factor contributes to your final credit score is as follows:
- 1. Payment history: Your payment history accounts for 35% of your credit score. It tracks how consistent you are at paying your debts and if you pay them on time.
- 2. The amount owed: The amount owed determines 30% of your credit score. This refers to the amount of credit you use each month. If you regularly use all or more of your available credit you are seen as unreliable and risky. The ratio of available credit to the amount borrowed is known as the credit utilization ratio.
- 3. Length of credit history: The length of your credit history accounts for 15% of your credit score. The longer you’ve been able to demonstrate financial responsibility, the better your score.
- 4. New Credit: This refers to how often you apply for loans or credit and accounts for 10% of your credit score. Regularly needing extra funding or loans can lower your credit score in the long term.
- 5. Credit mix: This refers to how many types of credit you manage, including credit cards or other types of loans. It accounts for 10% of your credit score. The more varied your credit, the better.
- Now that you know how your final score is calculated, you can take action and start building it up.
How To Build Your Credit Score Using A Secured Credit Card
Building credit with a secured credit card requires responsible financial management. To build credit, see the following guidelines and tips:
- Pay your bill on time: If you consistently pay your credit card bill on time it will reflect in your payment history and add up quickly. If you cannot pay the entire bill, make at least a minimum payment each month and pay the balance in full to avoid accruing interest charges.
- Keep your credit utilization low: As mentioned earlier, credit utilization is the ratio of used credit to the total credit available. Aim to use less than 30% of your credit each month to build your score faster.
- Be patient: The longer you demonstrate financially responsible behaviour, the better your chances of building positive credit.
- Avoid opening too many new accounts: Opening multiple new credit accounts within a short period can negatively impact credit scores.
- Diversify your credit mix: Generally, it’s unwise to take on more debt, but if it makes sense for your circumstances, try and diversify the debt. For example, taking on a credit builder loan or paying off your student loans alongside your credit card can demonstrate reliable behaviour.
- Monitor credit reports: Throughout this process, ensure that you keep an eye on your credit reports and catch any errors early on.
In the end, it comes down to being consistent, patient, and responsible with your credit card. Try to only use a little bit of your credit each month and then pay it off as soon as possible. Over time, this will create a payment history that demonstrates to future lenders that you can pay back your debts.
How To Apply For A Secured Credit Card
To start applying for a secured credit card, first, you need to research several banks and credit unions and get a rough idea of the rates, eligibility requirements, and fees for secured credit cards.
Once you know which secured credit cards suit your needs you can apply online or visit a local branch. During the application process, be prepared with the following information:
- Income details.
- Your security deposit.
- Personal information, such as identification details.
After the application is submitted, the card issuer will review the information and determine whether to approve or deny the application. If approved, you will need to make the security deposit before the card can be activated and used for purchases.
Final Thoughts
A secured credit card can be a valuable tool for improving your credit score. With a little patience, plenty of discipline and consistency, and well-timed payments, you can increase your credit score and set the stage to achieve your financial goals and dreams. Good luck!
