What Are Secured Credit Cards, and How Do They Work?

A secured credit card is a type of credit card that requires a cash deposit as collateral, which serves as your credit limit. Secured cards are typically used by individuals who are looking to build or rebuild their credit, as they provide a way to demonstrate responsible credit use when access to unsecured credit cards may be limited due to poor or no credit history.

How Secured Credit Cards Work

Security Deposit

To obtain a secured credit card, you must make a deposit with the card issuer. This deposit is typically refundable if you close your account in good standing. The deposit amount generally determines your credit limit. For example, if you deposit $500, your credit limit will likely be $500. Some issuers may allow a higher limit with a larger deposit.

Credit Use and Payments

Like any other credit card, you can use a secured card to make purchases up to your credit limit. The key difference is that the security deposit provides the issuer with a guarantee that they will be reimbursed if you fail to make payments. Secured cards report your credit activity to the major credit bureaus, so responsible use (such as making on-time payments and keeping your balance low) can help you build or improve your credit score over time.

Building or Rebuilding Credit

Secured credit cards are particularly useful for individuals with no credit history or those who have damaged their credit score. By using the card regularly and making timely payments, consumers can demonstrate positive credit behavior, which will be reflected in their credit reports. Over time, this can help improve your credit score and may eventually qualify you for an unsecured credit card.

Interest Rates and Fees

Secured credit cards often come with higher interest rates and fees compared to unsecured credit cards, so it’s important to be mindful of your usage to avoid accumulating unnecessary debt. However, some secured cards have low annual fees or offer features like cash-back rewards. Always read the card’s terms and conditions to understand the costs associated with the card.

Transitioning to Unsecured Credit

Many secured credit cards offer a path to transition to an unsecured card after you’ve demonstrated responsible use over a period of time (usually 6–12 months). This may involve the issuer reviewing your credit score and payment history. Once you qualify, you may be able to get your deposit refunded and have a higher credit limit without needing to provide collateral.

Benefits of Secured Credit Cards

• Build or Rebuild Credit: Secured cards are an excellent way to establish or improve a credit score, especially for those who have had difficulty qualifying for traditional credit cards.
• Low Risk for Lenders: The requirement for a deposit reduces the risk for lenders, making it easier for those with poor or no credit to be approved.
• Possible Upgrade to Unsecured Card: Many issuers offer the opportunity to transition to an unsecured credit card after demonstrating good payment behavior.

Drawbacks of Secured Credit Cards

• Initial Deposit Required: You need to have enough cash on hand for the required deposit, which can be a barrier for some consumers.
• High Interest Rates: Secured cards often come with higher interest rates than unsecured cards, so carrying a balance from month to month can be costly.
• Fees: Some secured cards charge annual fees, application fees, or monthly maintenance fees, which can add up over time.

How to Use a Secured Credit Card Effectively

• Make On-Time Payments: Timely payments are the most important factor in building a positive credit history. Pay your bill in full each month to avoid interest charges and late fees.
• Keep Your Balance Low: Aim to use less than 30% of your available credit limit to maintain a healthy credit utilization ratio and improve your credit score.
• Monitor Your Credit: Check your credit report regularly to track your progress and make sure your secured card payments are being reported accurately.
• Consider Upgrading: After six months to a year of responsible use, reach out to your card issuer to inquire about upgrading to an unsecured card and having your deposit refunded.

Example

Suppose a consumer with no credit history applies for a secured credit card and makes a $500 deposit. Over the next six months, they use the card for small purchases and make on-time payments every month. After six months, the consumer's credit score has improved, and they receive an offer to upgrade to an unsecured card, which allows them to access a higher credit limit without needing a deposit.