Your credit score is valuable. It is used for judging your credit worthiness for new lines of credit, it affects your interest rates and insurance rates, and it can be used as a determining factor when applying for a job, buying a cell phone, renting an apartment, and more. That is why it is so important to maintain a high credit score.
The Catch-22 of credit: It takes credit to build credit
You need credit to build your credit history, which can be difficult when credit companies aren’t willing to extend a new line of credit due to not having an established credit history or having a poor credit history. Unfortunately, there is no magic button to improve your credit score. It takes a steady stream on time payments, a decreased amount of debt owed, and time. It may seem impossible to increase your credit score if companies aren’t willing to give you a loan, but there is a way: using a secured credit card.
What is a secured credit card?
Secured credit cards look and act like traditional credit cards, but there is one key difference: secured credit card holders must deposit a sum of money which acts as collateral for your purchases. If you do not make your payments on time, the bank will use your deposit to pay your debts. The deposit also acts as your credit limit.
Secured credit cards can increase your credit score
Most secured credit cards are reported to the credit bureaus, so your credit score should improve with regular use as long as you make your payments on time and don’t go over your credit limit (the amount of your deposit held at the issuing bank). You should also understand how your credit score is determined and work toward improving all the factors that affect your credit score.
Who can obtain a secured credit card?
Most secured credit cards are open to anyone, including people with bad credit or no credit. Banks are not as concerned about you not making payments because you place a deposit with the bank which acts as collateral. If you don’t pay your bill, they simply take the money you put on deposit.
Pros and cons of secured credit cards
Anyone can open a secured credit card, including people with bad credit or no credit. So everyone should get one, right? Not so fast. There are pros and cons to having secured credit cards:
Advantages of secured credit cards:
Secured Credit Cards offer several major advantages to people looking to create or establish credit history, or simply improve their credit score.
- Easy Approval Process. Because the issuing bank holds a deposit as collateral, they will accept almost all applicants. Many people who cannot get approval for a traditional credit card can get approved for a secured credit card.
- Establish or re-establish credit. Secured credit cards can help you establish a credit history if you have not yet taken out a line of credit, or re-establish your credit if you have unfavorable marks on your credit report.
- Increase your credit score. Most secured credit cards report to the credit bureaus, so your credit score should improve as long as you make on-time payments.
- Security deposit in case of default. Your security deposit will be used in the event you don’t make payments, so you don’t risk taking on more debt.
- Interest on deposits. Some secured credit cards offer interest on the security deposit card holders leave with them. That means you may be able to earn a few bucks if you make all your payments on time and do not carry a balance.
- Conversion to traditional credit card. Some secured credit cards automatically convert to traditional credit cards within a certain time frame (sometimes 18-24 months), provided you make all payments on time and don’t go over your credit limit.
Disadvantages of secured credit cards:
Secured credit cards do a have a few limited disadvantages. however, they are usually the best place to start if you don’t have other options.
- Security deposit. Secured credit card holders have to “pay to play.” Secured credit cards require a deposit in the amount of the credit limit, and many people who don’t have credit can’t afford to pay a deposit to build their credit… another Catch-22.
- High fees. Most secured credit cards come with fees, sometimes including application fees, processing fees, and annual fees.
- High interest rates. Secured credit cards often come with higher interest rates than traditional credit cards. You can avoid the high interest rates if you pay your bill in full each month.
Are Secured credit cards worth it?
If you need to establish credit history from scratch or improve your credit due to an unfavorable credit report, then a secured credit card can help you do that. Despite the fees and high interest rates, a secured credit card may be the best way for you to increase your credit score, particularly when you are not able to obtain credit through any other means. You will probably do better to avoid secured credit cards if you can qualify for a traditional credit card or other line of credit.
*Note: Secured credit cards and prepaid cards are not the same. Prepaid credit cards are more similar to gift cards, but bear the name of a traditional credit card, such as Visa or MasterCard. They do not affect your credit score.