What is a Secured Credit Card and How Does it Work?

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Contributor, Benzinga
August 14, 2023

If you're looking for opportunities to build a positive credit score, consider a secured credit card. A secured credit card is a credit-building product designed for consumers with low credit scores. Secured credit cards are backed by a cash deposit from the cardholder, which offers security to the card issuer. The deposit acts as collateral and usually equals the card's credit line. Read on to understand what is a secured credit card and how it could help you. 

What Is A Secured Credit Card?

A secured credit card is a type of credit card that requires the cardholder to provide a security deposit as collateral. This deposit offers the card issuer security if the cardholder can’t pay. 

Does a secured card build credit? Yes! When you make on-time payments, the card issuer reports on-time payments to the three main credit bureaus, Experian, Equifax, and TransUnion. 

With a secured credit card, the amount you put in as a deposit will become your credit limit. This offers both you and the card issuer security in case you're unable to pay off charges later on. 

How Does A Secured Credit Card Work?

A secured credit card works like a regular credit card, except you'll make a security deposit ahead of time. What does a secured credit card mean? It means you get access to a secure credit line and the convenience of a credit card. Here's what else you need to know:

Application And Approval

The application process for a secured credit card is similar to a standard credit card. You'll need to provide information like full name, address, social security number, and income information. However, a secured card is typically easier to obtain compared to an unsecured card due to the collateral requirement.

Individuals with limited credit history or poor credit scores often opt for secured cards. Likewise, you may still qualify for a secured credit card if you don't have a social security number. 

Security Deposit

With a secured credit card, you'll be asked to put down a security deposit. The security deposit acts as collateral, providing a safety net for the issuer. The deposit amount often determines the initial credit limit on the card, offering a sense of control for the cardholder. 

Initial deposits range from $200 to as much as $5,000, depending on what you can offer and what you qualify for. Over time, the card issuer may increase the credit limit without asking for a higher deposit. 

Card Usage

A secured credit card can be used just like any other credit card for purchases, payments, and transactions. This includes everyday purchases at a grocery store or gas station, as well as online purchases. 

The security deposit sets the card's spending limit or credit limit. Usually, if you have a $200 security deposit, you can expect a $200 credit limit. You can ask for an increased credit limit with time and responsible usage. 

Monthly Statements And Payments

Like other credit cards, with a secured credit card, the cardholder receives monthly statements detailing their transactions, outstanding balance, minimum payment, and due date. 

To benefit from a secured credit card, making on-time payments is essential. You'll build positive credit and avoid late fees and negatively impacting credit.

Credit Reporting

Secured credit card issuers participate in credit reporting to one or more of the three main credit bureaus. When selecting a secured credit card, look for one that reports to all three credit bureaus to maximize credit-boosting benefits. By reporting to the credit bureaus, secured credit card issuers provide a crucial role in helping consumers build or rebuild credit. 

Responsible use, including on-time payments, is reported to credit bureaus, gradually helping to improve your credit score over time.

Credit Limit And Deposit Considerations

Some secured card issuers allow cardholders to increase their credit limit over time. This can be achieved by adding to the security deposit or demonstrating consistently responsible credit behavior. If you've met all on-time payment requirements for six months to a year, you can ask the card issuer about an increased credit limit. 

Account Management And Fees

Managing the secured credit card account effectively means minimizing interest or fees. Note that various fees may be associated with secured cards, such as an annual fee or application fee. Carefully review the terms before applying to avoid large unexpected fees. 

Secured Vs. Unsecured Credit Card

What are the differences between secured vs. unsecured credit cards? Here's what you need to know:

Collateral Requirement

Secured credit cards require collateral; cardholders must provide a security deposit upfront. The security deposit influences the credit limit on secured cards.

In contrast, unsecured credit cards do not require collateral. Credit limits are determined by the cardholder's credit score and credit history. 

Credit Approval

Secured credit cards are more accessible to individuals with limited credit history or poor credit scores. Approval for secured cards is based on the security deposit.

Unsecured credit cards are typically offered to those with better credit profiles.  Credit decisions are based on income and creditworthiness.

Credit Building

Both secured and unsecured credit cards can contribute to credit building when used responsibly. Timely payments, low credit utilization, and good credit behavior can help improve credit scores with both card types.

Interest Rates And Fees

Interest rates and fees associated with secured and unsecured credit cards vary by the card issuer and individual offer. In general, secured cards have higher fees due to the higher risk, while unsecured cards may have lower fees and potentially more competitive interest rates but may also come with a high annual percentage rate (APR). 

Rewards And Benefits

A secured credit card's main reward and benefit is building a positive credit history or improving your credit score. Other than those tangible benefits, secured cards may have limited or no rewards. 

On the other hand, unsecured credit cards often provide more attractive rewards programs, cash back, travel benefits, and other perks like signup bonuses.

Who Should Use A Secured Credit Card?

If you're wondering whether a secured credit card is the right option for you, consider these options. The following groups can benefit from a secured credit card:

  • Individuals with limited or poor credit history
  • People looking to build or rebuild credit
  • Those seeking to establish creditworthiness
  • Consumers with financial discipline goals
  • Individuals looking to gradually increase their credit limit

Building Your Credit Score

Secured credit cards can be a powerful credit-building tool. To build your credit history faster, consider also credit builder loans, becoming an authorized user, or using a rent reporting company. And remember, you're entitled to a free annual credit report from all three credit bureaus at annualcreditreport.com so you can monitor progress!

Frequently Asked Questions

Q

What are the benefits of using a secured credit card?

A

The benefits of using a secured credit card include building a positive credit history and building or rebuilding your credit score.

Q

Are secured credit cards different from prepaid debit cards?

A

Yes, although they function similarly, secured credit cards are different from prepaid credit cards in the way they can affect your credit score. Prepaid debit cards don’t report payment history to credit bureaus.

Q

How long does it take to upgrade from a secured credit card to an unsecured one?

A

How long it takes to upgrade from a secured credit card to an unsecured one will depend on the individual’s starting credit score, payment history, and responsible credit behavior.

About Alison Plaut

Alison Plaut is a personal finance writer with a sustainable MBA, passionate about helping people learn more about financial basics for wealth building and financial freedom. She has more than 17 years of writing experience, focused on real estate and mortgage, business, personal finance, and investing. Her work has been published in The Motley Fool, MoneyLion, and she is a regular contributor for Benzinga.