Having bad credit doesn't make it nearly as difficult to operate in a highly credit-based society as it has in the past. There are a lot of options for people with bad credit to be able to make purchases with a plastic card, and even rebuild credit while doing so.
Secured credit cards, also known as prepaid credit cards, offer the opportunity for consumers to make credit card purchases and begin improving their credit scores, but they can also have some potential pitfalls. Here are some things you should know about opening up a secured credit card.
How they work
A secured credit card is a line of credit based on a cash deposit, or collateral. For example, if the consumer opens up a $500 line of credit, he or she must put down a cash payment of $500 to secure future transactions. The issuing bank may offer cards with a fixed line of credit, or it may offer some ways to increase the credit line, including adding more cash to the initial deposit.
As the customer uses the card and makes regular and timely payments, the bank may report the activity to one or more of the three major credit reporting agencies, Equifax, Experian, and Trans Union. However, if the bank reports to the agency but shows the card as being secured, the activity may not count toward the credit score. It's important to talk to the credit card issuing bank to understand how they report to the agencies to know if a particular card will help in the credit-building process.
If a bank doesn't report card activity to any of the bureaus, or doesn't report in a way that will have a positive impact on credit score, then it really isn't worth it to have one when a debit card based on a bank account can be used in just about any situation credit is needed, and may not cost anything to use.
Timely payments matter
The cash that has been put down to secure the card can't be used as payment. Aside from the deposit, the card is similar to most other credit cards, so it is important to make payments on time.
Treat a secured card just like any other line of credit, and make payments on time and by paying more than the minimum payments. This puts the cardholder into good payment habits and the right mind-set for having a regular credit card. In other words, treat it like it isn't a secured card, not like a savings plan.
Know the terms of the deposit
The deposit made on a secured card may be required to kept by the bank for some time after the card is closed or upgraded to a regular unsecured line of credit. Because some charges may take a few billing cycles to be applied, such as foreign transactions, don't expect the deposit to be returned right away. Know the bank's terms before agreeing to the account.
Fees can be hefty
It can be very costly to use a secured credit card. Activation fees, interest fees, annual fees and other charges are generally much higher for secured cards than for unsecured cards to buyers with good credit. A $500 deposit could quickly translate to a credit line of $400 or less once the upfront fees are taken out.
A savings account won't earn much interest, but won't have the big fees associated with it as a secured card will. It's crucial to understand the fees ahead of time and decide if it's really worth it to use it as a credit-building tool or if it is better to let time heal the bad credit wounds.
This article originally appeared on MyBankTracker.com.