Having bad credit is a Catch-22. You need an active credit line to help rebuild your credit, but most lenders won’t extend you credit if you have a troubled financial past. In fact, most lenders set a credit score cutoff point and if you fall below it, you won’t qualify for any traditional credit card. While you may have some luck appealing to your personal bank, a more viable option is to simply get a secured credit card.
Because secured credit cards come with stricter terms, many lenders are willing to offer them to people with poor credit. But while these cards can be advantageous, they also come with drawbacks. Therefore, you need to consider the pros and cons of secured credit cards before you apply for one.
What Is a Secured Credit Card?
Secured credit cards get their name because the lender secures your line of credit with collateral. It works like this: You deposit money into an account and the lender generally offers you a line of credit equal to the amount you deposited, though sometimes your credit line will be less than your upfront deposit.
Most lenders require an opening deposit ranging from $200 to $500. So if you default on the credit card, the lender can use the money in the account to cover your debt. However, if you regularly make your payments on time, some lenders will increase your credit limit without requiring you to add more money.
The lender will report your payment history and debt amount to the credit bureaus each month, which can help or hurt you depending on how well you manage the account. Once you close the account and pay off your balance, the lender will return your deposit. Many lenders will also let you graduate to a traditional credit card after a year or more of timely payments.
In this way, secured credit cards can help people with bad credit improve their credit score while rebuilding their credit history.
Secured credit cards come with many advantages, especially for people who have little or bad credit:
1. Rebuilding Your Credit Score
The primary purpose of a secured credit card is to give you a chance to rebuild your credit rating so you can qualify for a traditional card in the future. You can do this simply by paying your bill on time every month and keeping your balance low.
2. More Spending Power
Hotels, airlines, and car rental agencies require a credit card to book a room, buy a ticket, or rent a car. Having a secured credit card instead of just cash or a debit card will enable you to make these purchases.
3. You Can Graduate to an Unsecured Credit Card
Many lenders that offer secured credit cards also allow you to graduate to an unsecured card once you’ve made payments on time for several months. Even if the lender doesn’t offer a graduation program, however, you can apply for unsecured credit cards after you establish a good payment record with your secured credit card.
4. Control Your Spending
Since secured credit cards typically come with lower limits than unsecured cards, you’ll have a cap on your spending. This will keep you from getting into too much debt, which, in turn, can hurt your credit score.
5. Earn Interest
Many lenders allow you to earn interest on your secured credit card deposit. As long as you keep your account in good standing, you’ll get your deposit back plus interest when you close your account or graduate to an unsecured card.
6. Access to Emergency Funds
Since most places take credit cards, you can use your secured credit line to pay for unexpected expenses when you don’t have enough cash on hand to cover them, such as a flat tire or emergency vet trip. That said, you will still be limited by your available credit, which may be low, and you will not be able to pay for emergencies in excess of this.
7. Lower Fees Than Some Credit Cards
A few lenders offer unsecured credit cards geared towards people with bad credit. While these cards will give you access to an unsecured credit line, they have a higher interest rate and more fees. In fact, most “bad credit” unsecured cards have twice the interest rate of a secured card and charge both an annual fee and a monthly processing fee, just for having the card in your wallet!
While secured credit cards offer significant benefits, there are important downsides that need to be considered before opening an account:
1. High Interest Rates
Secured credit cards typically come with a high interest rate that can snowball quickly. In other words, if you do not pay off your balance in full every month, the lender will charge interest on the remaining amount, which will compound every month as long as the balance goes unpaid.
For example, after a few months of only paying the minimum, you could be looking at hundreds of dollars in interest and fees alone, which may leave you unable to pay off your debt.
2. More Fees
With a secured credit card, you can’t enjoy the fee-free lifestyle that comes with a traditional credit card. Many unsecured credit cards offer low-interest rates, no annual fees, no monthly processing fees, and reasonable penalties. But even the best secured credit cards won’t match this. In fact, most secured credit cards not only charge an annual fee but also heftier penalty fees should you miss a payment, go over your credit limit, or have a returned check.
3. Low Limits
Many secured credit cards will give you a credit line up to $10,000, if you can deposit that much. Alternatively, if you only have $300 or $500 to deposit, that is what your credit line will be. Having a low credit limit can put you at risk for maxing out your balance quickly if you do not carefully watch your spending, and incur charges for interest and fees.
4. It’s Not Exactly “Credit”
With an unsecured credit card, you can apply for and receive a credit limit without having to put down a deposit. With a secured credit card, however, you need to front a deposit before you can receive the card. Plus, you’re limited to spending what you would have otherwise had in your bank account anyway.
This is simply a means for you to rebuild your credit; it’s not a card that extends you credit and offers no real advantage over your debit card in an emergency situation.
5. Some Lenders May Report Your Account as a Secured Credit Card
Typically, a secured credit card will look identical to an unsecured credit card on your credit report. But some lenders may specifically earmark your account as a secured credit card account which could hurt you if potential lenders view a secured credit card holder as a higher risk.
Should You Get One?
Secured cards are bare bones credit products. If you have decent or even marginal credit, you may qualify for a traditional credit card instead. Since traditional credit cards offer lower fees, higher credit limits, and perks such as cash back or travel rewards, if you can get one, they are often a far better deal.
However, if you have very limited or poor credit, you’re probably better suited for a secured credit card. Just make sure your credit problems are behind you before you apply. A secured credit card will only help you rebuild if you stay committed to paying on time and keeping a low balance. But if you miss a payment or max out the card, it could drive your credit score even lower.
Do your research before applying for any secured credit card to make sure you’re comfortable with the minimum opening deposit, annual fee, interest rate, and incidental fees. Also make sure the lender reports to all three major credit bureaus: Equifax, TransUnion, and Experian. Don’t forget to check if the lender has a return or graduation policy, either. If they do, you should be able to qualify for a traditional card with a better rate after a year or so.
Have you opened a secured credit card in the past? Did it help you improve your credit history and get back on track?