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A Secured Credit Card Can Be The Solution To Bad Credit

If you are among the millions of Americans with bad credit, odds are that you have a tough time getting a credit card, if you can even get one at all.

pixabay/ jarmolux

There are several options here. You can choose to wait it out until the bad information to fall off your credit report, which can take up to seven years. You could choose a credit card specifically designed for people with bad credit, which can end up costing more than its worth. Or, you could choose to get a secured credit card, which can benefit your credit and personal finances in several ways.

How secured cards work
A secured credit card work just like any other major credit card. You can use it at any retailer who accepts that particular type of card (Visa, MasterCard, etc.), and you can also use it to pay for goods and services that require a credit card hold, such as renting a car or staying at a hotel.

The only real difference is the "secured" part. In order to receive your new credit card, you are required to deposit money into an account with the issuing bank, generally in an amount equal to your desired credit line. So, if you deposit $500, you can get a $500 credit limit. Sure, it requires a substantial amount of cash, but unlike traditional "bad credit" cards, the money you put up remains yours, and will be returned to you when you close the account.

A secured credit card reports to the three major credit bureaus, and lenders will have no idea that it's a secured card. It will look just like any other credit card listing, with a payment history, credit limit, and balance information. This can be the best feature of a secured card, and I'll get into the specifics on how it can impact your credit score a little later.

So, how do you choose a secured card?

The best options
There are several options to choose from here. Basically, you want a card with a low annual fee and the lowest interest rate you can find. Ideally, you'll also find a card that will add to your credit limit as you establish a solid payment history.

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For example, the Wells Fargo Secured Card charges a $25 annual fee and currently has an interest rate of 18.99% which will change with the market. This is pretty close to the terms you can expect from a standard "good credit" card. You can deposit any amount from $300 to $10,000, and your initial credit line will be the same as the deposit amount. The bank reviews accounts periodically and cardholders with a solid payment history may become eligible for an unsecured card. The card has some other useful benefits, such as using it for overdraft protection on a Wells Fargo checking account and free access to online credit education.

Other products from Capital One and U.S. Bank have similar terms and benefits, so choose the card with the best benefits for your situation. In addition, U.S. Bank has several secured credit card products that offer rewards through partners like Harley Davidson and AeroMexico. These have slightly higher interest rates than the bank's basic secured card, but depending on how much you'll use the rewards, it may be worthwhile.

There are plenty of other secured credit cards to choose from, so do your research. Your own bank is a good place to start the search, as many offer the ability to link bank and credit accounts together.

How much of a difference can it make?
As long as you use the card responsibly, having a secured credit card can make a huge difference in your credit score, and the effects might be seen quickly. For example, 30% of your FICO score (the score lenders look at) comes from the amounts you owe on credit cards relative to your balance. Well, if you currently don't have any credit cards, this is an untapped portion of your score. As long as you keep your balance low (say, less than 20% of your limit), a secured card can really help this category.

Another 10% of your score comes from the types of credit you use. Essentially, lenders want to see a diverse mix of loans, credit cards, and other accounts. If you don't have a credit card right now, this category is not helping your score as much as it could.

And over time, other categories such as payment history (35% of your score) and length of credit history (15%) will benefit.

The bottom line here is that having a credit card in good standing is essential to establishing and maintaining better credit, and a secured credit card is a cost-effective and very beneficial way to get one.

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Comments from our Foolish Readers

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  • Report this Comment On August 23, 2014, at 3:27 PM, ekdikeo wrote:

    Tip: Credit unions typically offer secured credit cards as well. I started working in a business in which I was being required to travel frequently for work, and was being reimbursed travel expenses quite regularly.

    $2k put to a secured credit card, paid off every month by reimbursements from the company, and my credit score went from "credit companies laugh if i ask them for a dollar" to "american express and chase want to give me high 4 digit credit cards and people want to give me 5 digit car loans". Seriously. Six months.

    One year, and I've got the ability to instantly access 20k, if I were to need it. That ability stays tucked away where I will not ever use it except in case of emergency, but I do still have that secured card (until my primary non-secured account gets 18 months of history on it, i'm not closing the secured card). My current primary card has a 1.5% cash back on everything, a 5k limit, and i'm in a 1-year introductory 0% interest.

    After one year of putting all my expenses on a secured card and paying it off ASAP, I am for the next 11 months, literally getting 1.5% interest on everything I -spend-. I totally expect some other credit company will offer me some even better promotion before that year is up, and then this card will end up getting paid off and sitting idle.

  • Report this Comment On August 23, 2014, at 3:29 PM, ekdikeo wrote:

    oh, yeah, that 2k secured credit card with my credit union cost me nothing but the 2k, which is still in my savings account, and still earning me 0.05% interest on. The card came with 0% interest for 6 months, and has a ridiculously low 9% APR after.

    Non-CU secured cards tend to have the same or higher rates than regular credit cards, in the 18-24% areas.

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Matthew Frankel

Matt brought his love of teaching and investing to the Fool in order to help people invest better, after several years as a math teacher. Matt specializes in writing about the best opportunities in bank stocks, real estate, and personal finance, but loves any investment at the right price. Follow me on Twitter to keep up with all of the best financial coverage!

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