In case you’re living under a rock, the economy kind of stinks right now. Jobs are tough to find, college is expensive, and money is tight. And if you have no credit or poor credit, finding a credit card that helps establish or reestablish credit can be especially daunting.
Fortunately, secured credit cards can help.
"I had absolutely no credit history in the fall of 2013 (I was 23 years old) and couldn't get a car loan or even a regular credit card," says Allen Walton, owner of SpyGuy Security. "I knew I needed to raise my score, and the only way I could find was to get a secured credit card."
Because he paid it off in full every month for twelve months, by the end of the year he found himself with a higher credit score and higher credit limit without having to open any other credit cards or lines of credit or provide any additional deposits. What’s more, Walton started his own business last year: "It was very important to me to get a business card," he says. "Since I had to personally insure the credit card, I wouldn't have been approved if I had not gotten the secured card first."
Sign me up, amirite? But, first, let’s learn a little more about them and explore their pros and cons.
What is a secured credit card?
Secured cards work just like traditional credit cards and can be used in everyday purchases like groceries, gas, and clothes. They can also be used where cash and debit cards aren’t accepted, like renting a car or reserving a hotel room.
"Obtaining a secured credit card can help you build or rebuild your credit," says Kemberley Washington, CPA, member of the AICPA’s National CPA Financial Literacy Commission. "A secured credit card allows an individual to deposit a sum of money with a financial institution to be used as collateral. The collateral provides the financial institution assurance that in the event a payment is not made, the deposit could be utilized."
If you have no credit or poor credit, you are, essentially, an undesirable consumer. Why? Because the credit card companies don’t know if your payments will happen at all, let alone be timely. But by paying a security deposit, you give lenders confidence that you will pay. What’s more, since it’s your deposit money that sets the terms of the credit line (and doesn’t count towards payments like it does for a prepaid card), lenders are protected if you don’t pay.
How do secured cards build your credit?
"Secured cards report to the credit bureaus, which helps consumers establish their credit," says Julie Pukas, Head of US Bankcard and Merchant Services at TD Bank. "It's important to note that the product does not disclose to the bureaus as ‘secure,’ which is why they help to demonstrate a cardholder's stability, ability, and willingness to pay to lenders."
But what about unsecured cards from stores? Are secured cards better than them when it comes to building your credit?
"Store credit cards are unsecured and while they do help consumers establish a credit profile, these types of cards have limited utility for usage at the designated store only, which means that the bureaus will view these cards a bit differently as it relates to a credit score," says Pukas. "In the eyes of the credit bureaus, a cardholder's responsibility is limited to spending at one store and as such they need only to manage spending and payments in a limited arena. Using store cards to build credit will require customers to get and manage multiple cards which could create some challenges for effectively managing credit."
What are the pros of a secured credit card?
Obviously, a major advantage of a secured credit card is that it allows an individual to establish or build credit, says Washington. (Pro tip: Research, research, research before applying for a secured card. Make sure that the card you use reports to the national credit bureaus. If not, all your hard work and timely payments will be for nothing because your credit score will not be affected.)
If you maintain responsible credit behavior and provide timely payments, in addition to increasing your credit score, you may also be able to get an unsecured credit card, receive a refund of your collateral deposit, and qualify for lower insurance and mortgage rates.
What are the cons of a secured credit card card?
Some secured cards have higher than expected fees, says Sean Stein Smith, CPA and member of the AICPA’s National CPA Financial Literacy Commission. And while this is not terribly unusual for credit cards, they can sneak up on you if you’re not privy to them. Beware of hidden and high fees including annual, withdrawal, insufficient funds, and balance transfer fees so you don’t accumulate costs that you can’t handle.
Plus, if you default on your card (a.k.a. not paying your bills), the bank can keep your deposit.
And when it comes to secured credit cards, there are also little to no perks: "Many credit card offerings are based increasingly around perks such as points, discounts, or cash back incentives," explains Stein Smith. "All of these, of course, are ways to encourage more spending on the card, but as a general rule secured credit cards do not offer a similar range of benefits."
Where can I apply for a secured credit card?
Have I won you over? Does a secured credit card sound like a great idea? Check out CreditCards.com or Credit Karma (I know you’ve seen the commercials) to find the best card for you. These sites lay out reviews, pros and cons, and detailed information about each card, helping you find great options whether you have no or poor credit. (You can also reach out to your bank and see what options they have, especially if you have been a customer of theirs for a long time.)
Although having no or poor credit is tough, know that you’re not alone. Most importantly, know that you’re also not destined to be an apartment-dwelling, high interest-paying individual for the rest of your life. By researching credit card companies, finding one that reports to the national credit bureaus and doesn’t have too many crazy fees, and maintaining timely payments, you, too, can improve your credit score and find financial peace.