When used correctly, credit cards can help build credit. You may have trouble getting approved if you have bad credit or thin credit history. It’s a classic catch-22.
Secured credit cards are designed specifically for people in your situation. Unlike traditional credit cards, these cards have a few quirks, but they are easier to obtain and they can help build credit right away.
This is how secured credit cards work.
Who Secured Credit Cards Are For Secured credit cards are used by two main groups:
- People with bad credit who wish to improve it
- People with a thin or non-existent credit history
If you have bad credit or are just beginning to build your credit profile, a secured card may be beneficial to you. Your application could still be rejected depending on the state of your credit.
How Secured Cards Work
Secured credit cards require you to pay an upfront security deposit to the credit card company. Once your application is approved, you will need to submit this deposit.
Usually, your credit limit is determined by the amount of your deposit; for example, a $1,000 deposit will get you a card with a $1,000 credit limit, although some card issuers may offer a credit line greater than your security deposit. A minimum deposit of $200 is required for most cards.
The reason for the security deposit is simple: as someone with poor or no credit, you represent a greater risk to the card issuer, who is not confident you will be able to make your payments. If you stop paying, they will keep your security deposit.
In addition to that, secured credit cards work just like regular credit cards. If you don’t pay your balance in full every month, you’ll be charged interest. You can use them to make purchases, and they require monthly payments.
In some cases, your credit limit will be increased or even your deposit refunded after a certain time period, either automatically or upon request.
How Secured Credit Cards Build Credit
As with traditional credit cards, secured credit card activity is reported to the major credit bureaus. Using your credit card wisely will help you build the following factors that impact your credit score:
- Payment history: making timely payments every month will help you build a positive payment history.
- Account mix: you can also manage installment accounts (loans with fixed monthly payments for a predetermined time period) if you have a credit card.
- Debt utilization: you will demonstrate your ability to manage your credit card balance responsibly if you keep your balance low (under 30%).
- The average age of accounts: the older your accounts, the better your credit score will be. Your credit card will help you increase the average age of your accounts over time.
Choosing a Secured Credit Card
Choosing the right card depends on your specific situation. You should know where your credit stands and how much you can afford to put down for a security deposit before you begin researching credit cards.
Try to find a credit card with a competitive annual percentage rate (APR), but be aware that secured credit cards tend to have higher interest rates than traditional credit cards. Choose a card that has a low (or no) annual fee.
Although this isn’t the norm, some major credit card issuers, such as Discover, even offer secured credit cards with rewards. Make sure to evaluate all your options and weigh the costs of any card before applying.
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