What is a secured credit card?

Qualifying for a credit card can be a problem if your credit is damaged. It can also be difficult if you have a short credit history or you have not built up any credit history at all.

But there is an option if you can’t qualify for a traditional credit card: secured credit cards. These cards, which usually come with lower credit limits and little extras, can help you build up a credit score quickly or rebuild bad credit on a permanent basis.

But what are secured cards and how do they compare to unsecured credit cards? Keep reading to find out.

What is a secured credit card?

For the most part, you can use a secured credit card just like you would a traditional unsecured credit card. The main difference is that with a secured credit card you pay a refundable security deposit which acts as your credit limit and you cannot spend more than the amount. Basically, you are not actually borrowing money, because if you cannot pay what you owe, the credit card issuer will use your deposit to pay off the balance.

Secured and unsecured credit cards

Here is a quick overview of how these two types of credit cards differ:

Protected Credit Cards

• Security deposit required (refundable when you close an account in good standing)
• The security deposit acts as your credit limit
• Failed to pay and card issuer is using your deposit to pay
• Easier to qualify if you have a bad credit history as issuer risk is low
• The annual interest rate is often higher than that of an unsecured credit card

Unsecured credit cards

• Credit rating affects the interest rate and credit limit
• Difficulty qualifying with bad credit
• The annual interest rate is usually lower than secured credit cards.
• No deposit required – borrow money from your credit card issuer to make purchases

How do secured credit cards work?

There are some important similarities between unsecured and secured credit cards: You can use both types of credit cards to make purchases. You pay for these purchases every month. And if you don’t pay off all of your debt by the due date, you will be charged interest on the unpaid balance. Timely payments on each type of card improve your credit score, while late payments worsen it.

But there is one big difference between secured and unsecured credit cards, and it has to do with your credit limit.

With a secured credit card, you first make a deposit with the bank or financial institution that issued it. This deposit becomes your credit limit. If you deposit $500, you can withdraw up to $500 from your secure card. If you deposit $1,000, your card’s credit limit is $1,000.

Traditional credit cards, also known as unsecured cards, do not require a deposit from the borrower. Your past credit history determines your credit limit on an unsecured credit card. If you have a history of paying your bills on time and a good credit score, your credit limit will be higher.

Pros and cons of secured credit cards

There are some notable advantages and disadvantages of secured credit cards for consumers with poor or non-existent credit history:

pros

• Better chances of approval. With a secure card, your credit score isn’t as important as with a traditional card because you’ve made a deposit with your initial deposit. If you do not make your card payments on time, the bank or financial institution that issued your card may take the amount due from your deposit. Since this reduces much of the risk for issuers, secured cards are much easier to get approved with bad, little or no credit.
• Less risk of overspending and new debt. You cannot charge more than you put in, so your debt cannot exceed the amount you can eventually repay.
• Great tool to improve your credit history. Every time you make a timely payment on your secure credit card, it is reported to the three national credit bureaus – Experian, Equifax and TransUnion. As these payments are recorded, your credit score will gradually rise if you don’t have enough credit to build it, or improve slowly if your score is damaged by late or missed payments. Once your credit score improves, you can apply for a traditional credit card.

Minuses

• Limited purchasing power. Your credit limit will usually be lower if you use a secure card. This is because this limit usually depends on your deposit. If your deposit is small, say $300, your credit limit will also be low.
• No awards or privileges. Protected cards rarely come with rewards programs. As a general rule, when using a secure card, you are not eligible for cashback bonuses or free miles.

Tips for Using a Secure Credit Card

Here are a few ways to get the most out of a secured credit card.

To begin with, you should only spend what you can afford to pay off right away, so you can always afford to pay your bill every month and work on improving your credit score. Late payments will damage your credit history.

Another good reason not to charge too much is so that you can keep your credit utilization ratio good and low. A credit utilization rate below 30 percent helps boost your credit score. Paying the balance in full each month can help with this.

How long does it take for a secure card to become unsecured?

Good news? You can switch from a secure credit card to a traditional card if you keep your monthly payments on time. This will improve your credit score over time. And soon you’ll have a strong enough credit score to ditch your secured card and apply for an unsecured credit card. The provider that issued your unsecured card might even automatically renew you after, say, six months to a year of on-time payments with your secure credit card.

bottom line

Protected cards are an easy and affordable way to rebuild or start building up your credit and, in some cases, earn cash along the way. Use them diligently and remember to pay them in full and your credit may be strong enough to qualify for an unsecured credit card in a few months.

Dan Rafter has covered personal finance for over 15 years in publications ranging from The Washington Post and Chicago Tribune to Wise Bread, HSH.com and MoneyRates.com. His work has also been published online by Motley Fool, Fox Business, Huffington Post, Christian Science Monitor, and Time.