The negative effects of a bad credit score are familiar to anyone who’s been there:
- Difficulty qualifying for loans
- Higher rates and less favorable terms on loans for which you do manage to qualify
- Trouble qualifying for a security clearance with current or prospective employers
- Trouble securing an apartment lease
- Higher auto and home insurance premiums (in certain states)
- Subjective consequences, like strained personal relationships and lower quality of life
The causes of bad credit are even more diverse.
Personal bankruptcy, foreclosure, and other adverse events can seriously impact your credit score.
In less dramatic fashion, so too can neglect. Past-due loan payments, high credit utilization ratios, and overenthusiastic credit application patterns all erode your credit score over time.
For many consumers, the absence of a meaningful credit history is the root cause. If you’ve never applied for a credit card or cosigned a loan, your track record (or lack thereof) isn’t likely to inspire confidence from prospective lenders, landlords, insurers, and employers.
Secured Credit Cards: Get Your Foot in the Door
Secured credit cards are designed for two types of consumers:
- Those with thin or nonexistent credit histories – people looking to build credit for the first time
- Those with sub-par credit scores attributable to adverse credit events or benign neglect – people looking to rebuild credit
How to Qualify for a Secured Credit Card
Secured credit cards have much looser underwriting standards than most unsecured cards, especially premium cash back credit cards and travel rewards credit cards with generous rewards programs, expansive lists of value-added perks, and high spending limits.
No-Credit-Check Secured Credit Cards
A few secured credit cards require no credit check at all. The best in our book is the Cleo Credit Builder Card. Its benefits include:
- Use your card as little as once per month to keep building credit
- Low security deposit requirement
- Cash-back rewards on eligible purchases
- Cash advances (terms apply)
- Automatic bill pay
- Track your score in your account
With no security deposit required, applicants who can scratch up the minimum required security deposit (more on that below) are guaranteed approval. The catch is that no-credit-check secured cards tend to have higher annual fees, high APRs, restrictive terms, and no clear path to unsecured status.
Traditional Secured Credit Cards
Most secured credit cards do require a credit check. Precise FICO score requirements vary, but it’s very unlikely that you’ll qualify with a score below 500. FICO scores between 500 and 560 are iffy – some issuers might bite, some might not, and it may come down to extenuating factors, such as an open bank account or housing ratio. Most issuers that do run credit checks avoid applicants with recent or non-discharged bankruptcies. Unfortunately, the only way you’ll know for sure whether your application is approved is to apply.
Pro Tip: Our list of tips to improve your credit score rating has more simple strategies to improve your credit score and build your credit profile over time.
How Secured Credit Cards Work
Secured credit cards have several common characteristics:
- Security Deposits Held in Collateral Accounts: Secured credit cards are secured by a cash deposit held in a collateral account, usually an FDIC-insured savings account with a token yield. Once your secured credit card application is approved, you’re required to make your security deposit before you can begin using your card. The minimum deposit amount usually ranges from $200 to $500. A few cards, like Capital One Secured MasterCard, allow deposits as low as $49. Maximum deposits vary by card, but balances in excess of $10,000 are rare.
- Credit Limits Tied Closely to Security Deposits: Secured credit cards’ initial credit limits are usually identical to the initial security deposit amount: a $500 deposit begets a $500 credit limit. Some restrictive cards wall off part of the deposit – up to 50%, so that a $500 deposit begets a $250 credit limit. Many issuers allow cardholders in good standing to raise their credit limits with additional collateral account deposits, with or without an attendant credit increase application.
- Balance Payments: Like unsecured credit cards, secured cards require regular balance payments on a monthly schedule. Cardholders make these payments with cash on hand – not their security deposits, which remain untouched except in specific circumstances outlined below.
- Credit Bureau Reporting: Secured credit card issuers generally report credit utilization and payment patterns to the three major credit reporting bureaus: Experian, Equifax, and TransUnion. Before applying, review your cardholder agreement and disclosures to confirm that this is in fact the case for your issuer. Assuming your issuer does report, responsible use and timely payments can raise your credit score over time.
- Higher APRs: With some notable exceptions, secured credit cards generally have higher APR ranges than unsecured credit cards. Regular APRs above 20% are common, even in low-interest-rate environments. Low APR introductory promotions are nonexistent. Secured credit cards issued by credit unions tend to have lower APRs, but those cards generally require credit union membership and therefore may not be available to the general public.
- Annual Fees: Most secured credit cards carry annual fees. These fees are usually modest by premium credit card standards: $25 to $50 is a typical range. The few secured cards that don’t charge annual fees typically have stricter underwriting requirements and are therefore likely off-limits to severely impaired applicants.
- Security Deposit Forfeiture and Refund: Security deposits remain safely ensconced in collateral accounts until one of two things happen: the credit card account becomes seriously delinquent, or the cardholder pays off the card’s balance in full and closes the account. In the first instance, the issuer seizes part or all of the security deposit, depending on the size of the past-due balance. In the second instance, the issuer returns the security deposit, with interest if applicable, to the cardholder.
Pro Tip: Curious about how secured credit cards actually look in practice? Check out our list of the best secured credit cards for rebuilding credit. We regularly update it with the latest information and promotions, so it’s a great resource for the best possible deals on secured cards too.
Advantages of Secured Credit Cards
1. Can Qualify With Imperfect Credit
You don’t need great credit to qualify for a secured credit card. That’s kind of the whole point. If you have a good credit score and strong credit history, you’re likely to qualify for an unsecured card with lower rates, better terms, and more generous rewards. Why would you choose an inferior option?
2. May Improve Your Credit Score and Build Credit Over Time
Virtually all secured credit card issuers report users’ credit utilization and payment patterns to the three major credit reporting bureaus.
If you hold up your end of the bargain and use your card responsibly, this regular reporting could raise your credit score and build your credit profile over time. Assuming no setbacks elsewhere, you’re likely to find yourself in a significantly better position a year or two down the road.
Pro Tip: Before you apply for a secured credit card, read the fine print or call the issuer to confirm that it does in fact report to the three major bureaus. With so many choices out there, you have no incentive to use a secured card with no possibility of building your credit.
3. Makes Certain Types of Transactions Possible
Secured credit cards are decidedly nontraditional, but they’re still credit cards. With that designation comes some important privileges and conveniences. Two in particular deserve attention:
- Flexibility to Make Emergency Purchases. When the unexpected happens, your secured credit card’s credit limit provides an important (and potentially decisive) cushion. If you don’t have enough cash in your bank account to cover an emergency auto repair bill or impound fee, to cite but two common examples, you can charge it to your secured card and pay it off over time. While it’s always preferable to pay off credit card balances in full, especially when the interest rate is on the high side, losing some money to interest charges might be preferable to the alternative.
- Ability to Make Deposits and Reservations. Some travel merchants, such as hotels and rental car companies, require credit cards to secure reservations or cover potential damages during a stay or rental period. Traveling long distances without a credit card in your wallet is not recommended.
4. Deposits May Earn Interest
Many secured credit cards, though not all, earn interest on security deposits held in collateral savings accounts. In most cases, yields are nominal – less than 0.5% APY, and often less than 0.2% APY. Some secured cards backed by credit unions offer more attractive yields – as high as 3% APY, in some cases. Regardless, any yield is better than no yield when it offsets the (likely) recurring annual fee.
5. Everyday Spending May Earn Rewards
It’s not uncommon for secured credit cards to earn rewards, most often cash back or travel points at modest rates. The Discover it Secured Credit Card, for instance, earns 2% cash back on qualifying purchases made at restaurants and gas stations – up to $1,000 per quarter combined. All other qualifying purchases earn 1% cash back, with no caps on earnings. And, while not technically a secured card, the Petal® 2 “Cash Back, No Fees” Visa® Credit Card is appropriate for new-to-credit applicants. Not to mention, Petal 2 earns up to 1.5% cash back on most purchases and 2% to 10% cash back on purchases with select merchants.
6. De Facto Cap on Credit Card Spending
Though secured credit cards’ relatively low spending limits are usually held out as a drawback (see below), the security deposit itself provides a de facto cap on credit card spending. Secured credit card users can’t fall too deeply into debt, if only because they can’t overspend their security deposits.
7. Opportunity to Graduate to an Unsecured Card
Many secured credit card issuers define clear “graduation” pathways for responsible cardholders. Precise policies vary, but cardholders who make timely payments can typically upgrade to unsecured cards in as little as six to nine months. (Some cards have longer runways – a year or longer.) If you’re happy with your current issuer and you don’t want to go through the hassle of searching for an unsecured card elsewhere, this is a great opportunity to take the next step in your credit journey.
Disadvantages of Secured Credit Cards
1. Usually Requires Some Credit History
Most secured credit cards require pre-approval credit checks. They thoroughly examine your credit history – the good, the bad, and the ugly.
Pre-approval credit checks look at your credit score too, of course. If you’ve had a major adverse event in the very recent past, such as a non-discharged bankruptcy, you’re unlikely to qualify for most secured cards. That’s sort of ironic, given that secured credit cards are designed to build credit for people who could use a hand, but it is what it is.
A few cards don’t require pre-approval credit checks, but they tend to have higher rates, more onerous fees, and less favorable terms overall. If you’re a first-time credit user or have truly abysmal credit, think carefully before applying for a secured credit card.
2. Likelihood of Higher Interest Rates
By and large, secured credit cards have higher interest rates than unsecured credit cards. There are some important and notable exceptions: DCU Visa® Platinum Secured Credit Card’s APRs start below 10%, a fantastic rate for any credit card. But, by and large, secured cardholders have to pay a premium for the privilege of using credit.
3. Higher Fees
Most secured credit cards charge annual fees, usually between $25 and $50. That’s a distinct drawback relative to run-of-the-mill rewards credit cards and low APR products for consumers with good to excellent credit.
Secured cards that allow balance transfers and cash advances typically charge higher fees for those transactions as well – up to 5% of the transaction amount.
And cards with looser underwriting standards may impose additional, unorthodox fees, such as monthly insurance premiums. It’s not a given that issuers will be upfront about these fees, so it’s up to you to read the fine print in your credit card disclosures and check for complaints filed with consumer protection authorities.
4. Relatively Low Spending Limits
A secured credit card is not a license to spend. Even if you have the means to make a sizable security deposit, you’re limited by issuer-imposed caps – rarely more than $10,000, and often less than $5,000. If you need to finance a major purchase, such as a big home improvement project or a new car, a secured personal loan (see below) is likely a better call.
5. You Usually Can’t Outspend Your Security Deposit Without Paying Off Your Balance
With rare exceptions, you can’t overspend your secured credit card’s security deposit without paying off your card balance. This isn’t ideal for cardholders who want the flexibility to carry a balance from month to month.
Pro Tip: Be cautious with your secured credit card spending, even if your monthly income and spending limits tempt you to loosen your belt. The best way to build credit with minimal cost or downside risk is to charge a handful of purchases to your secured card each month and promptly pay them off in full.
6. Credit Bureau Reporting Might Not Be Discreet
Before you apply for a secured credit card, ask the issuer how it will look on your monthly credit reports. In most cases, the entry won’t look any different than an unsecured credit card’s. But some issuers add notes to secured credit card reports that give the card’s nature away. When you apply for another loan or credit card and the lender pulls your credit, they’ll see that you have an active secured credit card account. Depending on their underwriting practices, that could be a red flag that lessens your approval chances.
7. Potential for Damage to Your Credit Score
Credit is a privilege, not a right. If you’re not careful with your credit utilization or careless about when and how you make payments on your balance, you could actually hurt your credit score. Missing statement due dates is a big no-no, for instance. Be honest with yourself: If you’re not ready for a credit card of any sort, acknowledge that, work on your financial fitness, and circle back when you feel better about your ability to handle a credit card of your own.
8. No Security Deposit Access Until Your Account Is Closed
When you send in your security deposit, you’re kissing it goodbye until you pay off your balance and close your account – or default, a much less favorable outcome.
If your cash flow is barely positive, it’s easy to envision a situation in which you’d need the funds earmarked for your security deposit. Do your budget a favor and wait until you have more financial breathing room to apply for a secured credit card, or look to an alternative that doesn’t require an up-front security deposit that’s then locked away for months or years.
Alternatives to Secured Credit Cards
Applying for a secured credit card is not an essential step on your credit-building or -rebuilding journey.
Millions of people for whom secured credit cards are technically appropriate never actually use them. If you’re wary of the secured credit card drawbacks cited above, these alternatives are legitimate and reasonably popular.
High APR Unsecured Credit Cards for Impaired Credit
Secured credit cards don’t have a monopoly on the credit-building market. There’s a small but stable cohort of unsecured credit cards catering specifically to cardholders with sub-par credit. Some cards, such as Capital One Platinum Credit Card, cater to applicants with FICO scores below 600.
Unsecured credit cards don’t require up-front security deposits. The rub is that they typically have high regular APRs – in some cases, higher than secured credit cards’. Plus, their initial credit limits tend to be on the low side, often below $1,000. And their underwriting standards aren’t quite as lax as most secured cards’ – a recent bankruptcy will definitely disqualify you. High APR unsecured cards generally lack rewards programs, a drawback next to the more generous secured cards.
- Consumers who lack liquidity to cover secured cards’ security deposit requirements
- Decoupling cash on hand (security deposit) and spending/credit limit
- Spending with a revolving credit facility
- Carrying balances from month to month
- Taking the first step after bankruptcy or an accumulation of adverse credit events
- Earning rewards for everyday spending
Secured Personal Loans
Like secured credit cards, secured personal loans are backed by borrowers’ cash. Unlike secured cards, which are revolving credit facilities, they’re fixed installment loans.
Secured personal loans have long been issued by banks and credit unions, where they’re sometimes known as “share secured loans.” They’re secured either by a share of the existing balance in the borrower’s savings account, or the balance in a collateral savings account opened specifically to cover the loan.
Compared with other types of secured loans, such as mortgages, secured personal loan rates are high. However, they’re not nearly as high as the rates on unsecured loans issued to credit-impaired borrowers, which can approach 30% APR. If your credit is really poor, your best bet is to work through an institution (preferably a credit union) with which you have an existing relationship.
In recent years, alternatives to the traditional secured personal loan model have emerged. Self Lender, an online lender with a branded credit product called the Credit Builder Loan, gives borrowers a one-year runway to build credit with monthly deposits into a collateral account. The deposits are reported as installment loan payments to the major credit reporting bureaus, theoretically improving the borrower’s credit score over time. Once the account is fully funded, the borrower can withdraw the full amount or roll it into a new Credit Builder Loan account to continue building credit. Since no credit score is required to apply, the Credit Builder Loan is ideal for first-time borrowers.
- Taking the first step after a major adverse credit event (possibly)
- Working with a familiar lender
- Making predictable payments over time
- Controlling credit utilization from month to month
- Increasing or decreasing spending power over time
- Consumers with limited cash on hand
Many types of installment loans, both secured and unsecured, are available as cosigned loans. Your cosigner is a trusted individual, most often a parent or spouse, who agrees to assume responsibility for the loan.
If you default on the loan, the cosigner essentially agrees to clean up your mess by paying the remaining balance. For this reason, lenders hold cosigners to high standards – they need very good credit scores and strong, lengthy credit histories.
Since cosigners expose themselves to substantial financial and credit risk, they’re in short supply. If you know someone willing to go out on a limb to cosign a loan for you, you owe them one – and you owe it to yourself not to let them down.
By the same token, if you do know someone willing to cosign a loan with you, and you’re quite confident that you can pay it off without trouble, it’s wise to take that opportunity rather than apply for a secured credit card on your own.
- Securing a prime rate with a subprime credit score
- Increasing borrowing power
- Spreading borrowing risk
- Borrowers who wish to retain their independence
- Controlling credit utilization from month to month
- Avoiding potentially awkward interpersonal situations
Entry-Level Unsecured Rewards Credit Cards
“Entry-level unsecured rewards credit cards” is not an official term used by credit card companies (or anyone else I’ve come across, for that matter). But it does accurately describe a class of credit cards that lives a step or two up from the high-APR unsecured credit cards referenced at the top of this section.
Entry-level unsecured rewards credit cards are often variants of better-known rewards credit cards. For instance, the Capital One QuicksilverOne Cash Rewards Credit Card is a less generous iteration of the Capital One Quicksilver Cash Rewards Credit Card, a much better-known product backed by a multimillion-dollar advertising campaign. (Pitchmen have included Samuel L. Jackson, Charles Barkley, and Spike Lee.)
Entry-level unsecured rewards cards typically have higher regular APRs, less generous rewards programs, lower spending limits, fewer value-added benefits, and (in some cases) annual fees. They’re designed for consumers who’ve begun their credit-building journeys elsewhere – perhaps with a cosigned loan – but have yet to arrive at a place where premium credit cards and prime-rate home loans fall from the trees.
- Controlling credit utilization from month to month
- Financing everyday purchases
- Earning rewards on everyday spending
- Carrying balances from month to month
- Taking the first step after a major adverse credit event
One Last Thing…
Another type of credit card that arguably qualifies as an entry-level product is the student credit card.
Most student cards are designed for college students. Like general-audience entry-level unsecured cards, they’re designed for consumers with limited or challenged credit, but applicants need to prove that they’re enrolled in a higher education program (or recently graduated) to qualify.
Most student credit cards earn modest rewards, usually in the form of cash back. Some offer good student discounts or bonuses – for instance, Discover it Chrome for Students pays you $20 every year your GPA stays above 3.0.
Further Reading: There’s one last type of plastic card worth mentioning: the reloadable prepaid debit card.
Prepaid debit cards don’t report to the major credit reporting bureaus, so they’re not suitable alternatives to secured credit cards for those seeking to build or rebuild their credit. But they’re quite useful for budgeting purposes and can even replace traditional bank accounts in the right circumstances.
At one of the first jobs I ever held, a bottom-of-the-barrel call center gig, my new supervisor closed the group orientation session with a matter-of-fact prediction I’ll never forget: “In three years, none of you will be here.”
The remark was ominous, sure, but refreshingly realistic too. He was just stating the obvious, in effect: “You shouldn’t want to work at an entry-level job paying just north of minimum wage for any longer than you have to. Move up, or we’ll help you move out.”
Like entry-level jobs, secured credit cards are a means to an end. They serve a vital purpose for credit-building consumers who can’t yet qualify for unsecured credit cards. Used responsibly, they serve as a bridge to credit cards with more attractive rates and terms, not to mention home loans and other vital types of credit – just as menial, low-wage jobs lift hardworking young people up to more meaningful work.
But, like the jobs in which most of us started, secured credit cards aren’t built for the long haul. Why aspire to hold onto the same secured credit card for five years when you can slowly but surely improve your credit with responsible use and graduate to an unsecured alternative in 12 or 24 months? Greener pastures await.
Do you have a secured credit card? Have you used one in the past?