A secured credit card is similar to a traditional credit card in many ways, and it can be a useful financial tool for several reasons. Offered by many major banks and credit unions, secured cards can help you build up your credit score while making your everyday life easier. They can also help to keep your spending in check.
Here's a primer on secured credit cards and what they could do for you.
How secured credit cards work
A secured card is a type of credit card that requires the user to put down a deposit as collateral in order to obtain a card. Usually the deposit requirement is equal to the credit limit (the amount you are allowed to spend).
Different from a debit card: Although you have to put a deposit down, don't confuse secured cards with debit or prepaid cards. Unlike those account types, a secured card must be paid back like a regular credit card. Your deposit amount doesn't change in value until you pay off what you have spent.
For instance, if you deposit $500 to obtain a secured card with a $500 limit and then charge $200 worth of purchases, your deposit account will still have $500 in it. You'll simply owe the card issuer $200 (plus any interest charges and other fees).
Where to get one: Secured cards are issued by many major banks and credit unions, and many banks offer incentives or the ability to link a secured card to an existing checking or savings account. So, a good place to start your search is with your current financial institution. If your current bank doesn't offer a secured card, search around and compare the fees and interest rates available from different institutions.
How to use it: Once you open a secured card account, it works identically to a standard major credit card. It is accepted at all merchants that accept that particular type of card (Visa, MasterCard, Discover, or American Express), and the card itself will not be identifiable as a secured card.
The benefits of a secured card
Secured credit cards offer several benefits to cardholders:
- It helps build your credit: Unlike a debit card or a prepaid credit card, secured credit card accounts are usually reported to the three major credit bureaus. If the issuer doesn't report your account, you can request that it does so. So long as you pay your bill on time and use your card responsibly by not "maxing out" your available credit, you should see your credit score improve over time.
- It gives you access: Secured credit cards allow you to do things that generally require a major credit card, such as renting a car or reserving a hotel room.
- It limits your spending: With a secured card, you can only spend as much money as you've deposited. In other words, you can't spend money you don't have.
While most secured credit cards offer similar rates, fees, and terms, keep an eye out for:
- Unusually high interest rates: Secured card interest rates should be comparable to those of a standard credit card (around 14% to 20%). If a card comes with a higher rate, look elsewhere.
- Excessive fees: You'll probably have to pay an annual fee for a secured card, and anything under $50 per year is reasonable. However, beware of cards that charge a monthly fee or an application fee, as you shouldn't have to pay either of these.
The bottom line
If you do not qualify for a traditional credit card and want to establish or rebuild your credit, a secured card might be a good option.
Matthew Frankel owns shares of American Express. The Motley Fool recommends American Express. The Motley Fool owns shares of Capital One Financial. and JPMorgan Chase. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.