If you have no credit or bad credit, one of the best ways to improve your credit is with a new credit account with a perfect payment history. But when you have bad or no credit, getting a new credit account can be very difficult. It may even seem impossible. But there is a solution to get new credit when you have a bad history: secured credit cards.
Secured credit cards are a type of credit card that shows up on your credit report like any other, but it does not work like a typical credit card in some ways. To learn how secured credit cards work and whether they make sense for you, follow along with this beginner guide to secured credit cards.
What is a secured credit card?
A secured credit card is a type of credit card backed by a deposit. In most cases, account holders will have to put down a refundable deposit equal to the value of the credit line. For example, if you want to open a credit card with a $1,000 limit, you would have to put down a $1,000 deposit when opening the account.
Thanks to the deposit, there is virtually no risk that the bank would lose money. This makes banks and other card issuers much more willing to open a new credit account for a risky borrower. In some cases, an issuer will even open up a secured credit card with no credit check at all, as they would open a secured account either way.
If you do decide a secured card is right for you, you’ll want to follow a set of guidelines to ensure the card helps build your credit while minimizing any costs and fees you pay out of pocket. In the next section, we’ll look at how to use a secured credit card to improve your credit.
Using a secured credit card to build credit
Every credit account you open in the United States is typically reported on your credit report. Your credit report is then used to calculate your credit score. A higher credit score can open up opportunities for better credit cards, auto loans, mortgage loans, and lower interest rates. A good credit score is a good thing to have!
Secured credit cards are best for people who need to turn around a bad credit score. Whatever happened in the past, using a secured credit card can help you re-establish yourself as a high-quality borrower.
Start by always paying your card balance in full every single month with no exception. Secured credit cards tend to charge high-interest rates, and late and missed payments can severely lower your credit score. Set up automatic payments to ensure you never make a mistake.
There is no secret, that’s really it! You’ll also do best to keep your balance less than 20% of your total available balance, as that’s another factor that impacts your credit score. The longer you keep any credit account open with a low balance and perfect payment history, the more it helps your credit score.
Secured credit card fees
One place to look out when using secured credit cards is the fees. Card issuers know applicants for secured cards have few other options and are at a high risk of not paying, so they make up for that risk with high fees and high-interest rates.
Most secured credit cards charge an annual fee. Annual fees are sometimes worth it, but if you can find a secured card with no annual fee, that is a better option. The Capital One Secured Mastercard and Discover it Secured Card are both good options with no annual fee.
Also look out for other usage fees. Late payments, cash advances, and foreign transactions are all common places to get swept up paying more and more. Avoid fees wherever you can. It’s better to keep that money in your pocket.
By paying off your card in full every month, you’ll avoid interest charges, which can be quite high on secured credit cards. In some cases, issuers charge nearly 30% APR. Pay your card off in full every month and you won’t have any interest to worry about. Even better, put the card at the back of the drawer and only use it and pay it off every few months. That way you have little risk of making mistakes.
The sweet spot: build credit and avoid costs
For secured credit cards to make sense for you, you’ll want to avoid high costs and work toward a goal of building credit. Unless you have a secured credit card with no annual fee, you may want to just keep it for a few years while building credit before upgrading to a new card with no fees and closing the old secured card.
But during the time you have the card open, you should use it responsibly to reach into the higher tiers of credit scores. The best credit cards, loans, and interest rates are for borrowers with “excellent” credit, which starts around 720-740 up to a perfect 850 credit score.
While some card issuers are upstanding companies, read all of the fine print and look out for anything suspicious. You don’t want to open up a new secured credit card just to find out it costs more than you expected and won’t help you realistically reach your credit goals. Spend time researching every card, limit it down to your top options, and you should be in good shape moving forward.
Should you get a secured credit card?
Secured credit cards do not make sense for anyone with good or better credit. Those brand new with credit, usually young people and new immigrants, may be able to avoid a secured card by looking for student credit cards or cards with lenient credit approval requirements.
But if you have bad credit and want to turn it around, a secured credit card can help. As long as you pick the right card, use it responsibly, pay it off in full each month, and avoid fees, your card should treat you well. That’s what building a great credit score is all about.