Everything You Need to Know About Secured Credit Cards

Secured credit cards help you build credit when you can't qualify for an unsecured card. But there could be high fees charged, and you need to make sure to find the right card to meet your needs.

When you charge on a credit card, typically the card issuer has no guarantee you'll pay back the debt you've taken on -- other than your promise to pay. Credit cards secured only by your word are called unsecured debt. To obtain one of these cards, you need to have at least fair or good credit so lenders will have confidence you're likely to pay back what you've borrowed.  

Sometimes, however, getting an unsecured credit card isn't possible. This can happen if you have a low credit score because of past mistakes or if you don't have a good credit score because you've not yet borrowed enough to establish a positive payment history.

Since you need to get access to credit to show you can pay your bills on time and boost your credit score, you're in a tough position if credit card issuers and other financial institutions won't lend to you. If you find yourself in this situation, secured credit cards could be the answer.

What are secured credit cards?

Secured credit cards are credit cards that provide the card issuer with a better guarantee of repayment than just your promise. There's collateral associated with these cards, which secures -- or protects -- the lender's interests.

Collateral is something of value lenders can take when debt isn't repaid. With secured credit cards, typically money acts as collateral. You deposit money with the lender into a special account and the lender extends you credit equal to the amount of money you deposited. For example, if you got a $500 secured card, you'd deposit $500 with the lender to guarantee the line of credit.

There's no risk at all to lenders in giving you a secured card, since if you don't pay your bills, the lender can just take the money securing the debt. Because there's no risk, credit card issuers will give secured credit cards to almost anyone. It doesn't matter if you've just come out of bankruptcy or have no credit history -- you can still get a secured card.

How do secured credit cards work?

When you apply for a secured credit card, your income and ability to pay the debt may be considered in deciding how large of a credit line to extend you. You'll then have to deposit collateral in a security deposit account.

The amount of your deposit is often equal to the line of credit, so you'd have to deposit a full $500 if you were given a $500 limit on your card. Sometimes, however, a card issuer will allow you to post a smaller deposit if your credit isn't too bad. For example, you may be able to deposit just $50 for a $200 line of credit, depending upon your current financial situation.

You'll usually have to pay a host of fees for the secured credit card, which can vary by lender.  There may be an application fee, annual fees, and foreign transaction fees. Secured cards will also typically have pretty high interest rates if you carry a balance.

Once you've been approved for the card and you've received it, you can use the card to make any purchases you want, up to your credit limit. You'll receive a monthly bill, which will require you to make a minimum payment based on the amount you've charged. The money that's serving as collateral isn't used to pay the monthly payment -- it stays in the secured deposit account. Instead, you'll need to pay the bill from other funds, either electronically or by mail.

What's the point of getting a secured credit card?

It may seem silly to pay a fee for a credit card when you're only allowed to borrow up to the amount you've deposited with the card issuer. But, there are times when it makes a lot of sense to get a secured credit card.

If you can't qualify for a regular credit card or for other types of loans because your credit score isn't good enough, obtaining a secured credit card gives you the chance to build a positive credit history. When you use your card and pay the bill on time each month, this record of on-time payments is reported to the three major credit bureaus -- Equifax, Experian, and TransUnion. Your history of on-time payments increases your credit score, so lenders won't think it's as risky to extend you credit.

Over time, your credit score should improve a lot if you pay your secured card's bill on time all the time. You'll need to charge at least a small amount each month so you have a bill to pay off, and will need to pay on time -- and ideally, pay in full so you don't get stuck with high interest.

Once your credit score has improved, you can start applying for other types of debt, including for unsecured credit cards. Some secured cards will also convert to unsecured credit cards after you've made a set number of on-time payments and have proven you can be responsible with borrowing.

What to watch for when getting a secured card

If you want to get a secured card to build your credit, you'll need to make sure you get the best card possible.

You should look for a card with no annual fee, or with very low fees so you can minimize the costs associated with your card. If you suspect there's a chance you may carry a balance, you'll also want to find the lowest interest rate possible. Remember, though, that it will always be expensive to carry a balance and pay interest on a secured card -- so you should do everything possible to avoid this.

You also need to make sure the card issuer reports your account and payment history to the the three major credit reporting bureaus. It does you no good to develop a positive payment history if the card issuer doesn't report your responsible borrowing behavior.

Finally, you may want to consider other alternatives to a secured card first, such as a store credit card that reports to the credit reporting agencies. Store credit cards can be easier than regular cards to qualify for -- although not as easy as secured cards -- and you won't have to pay fees or put down collateral for them.

If you can't get any other card, though, get a secured card ASAP as soon as you find a good one and have the cash to put down as collateral. Then, commit to being 100% responsible with paying off your bill in full and on time every month so you don't spend more than you need and so you can start to improve your credit.

Is getting a secured credit card right for you?

Whether you should get a secured card or not will depend upon your situation. When you don't have access to other credit, secured cards can be an important tool to help you earn the credit score you need to qualify for more favorable financing. Just be sure to shop around to find an affordable card that reports your payments so you get the credit-building benefits secured cards should provide.