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How do you start to rebuild your credit when you can’t get approved for a line of credit in the first place?
Let’s use this as a scenario: A consumer takes out a reasonably-sized loan. Maybe it’s for school, maybe for a house, maybe to start a small business. They make their payments on time and their debt slowly starts to dissolve.
Then, something bad happens.
Whether it’s a medical emergency or some other personal disaster, the borrower is no longer in a position to make their payments. They scrape and scramble to pay what they can, but their credit score continues to tank. When the dust settles, they can’t even get approved for a credit card.
This story is all too common, and the way forward isn’t always clear.
But a secured credit card might be able to help.
Whether you have a rocky credit history or have yet to establish one, a secured credit card is a great way to safely raise your score over time. Here’s what you need to know about how they work and how to use them.
What is a Secured Credit Card?
A secured credit card is halfway between a traditional credit card and a debit card. The main difference between the two is that issuers who provide secured credit cards require a cash deposit to act as collateral before giving out the card.
The deposit must usually be the same amount as the credit limit. For instance, if you get a card with a $200 credit limit you’ll have to deposit $200 of your own money. Sometimes you might qualify for a card with a deposit less than the credit limit, but it’s not very common.
Just like a security deposit pays for any damages you might incur while renting an apartment, a secured credit card deposit reassures the credit card company that you won’t run up a balance and then default.
Borrowers typically take out secured credit cards because their credit isn’t good enough to qualify for a normal card, or because they don’t have any credit history. A normal credit card generally requires a score of 600 or more, and a score of 700 or higher is usually necessary for a first-rate cash back or travel rewards card.
How to Build Your Credit with a Secured Credit Card
Building a credit score can be a bit of a Catch-22. To build your credit, you need to apply and be approved for credit – but to be approved, you need good credit already.
That’s where secured credit cards come in. They report your activity to credit bureaus, allowing your credit to improve as you use the card. Since card providers ask for a deposit, they’re protected in case you stop making payments. It’s a win-win for everyone.
Many consumers get prepaid cards and secured credit cards confused with one another, but they act very differently. Prepaid cards are more like gift cards or debit cards than credit cards, and using them won’t help you establish a solid credit history like secured cards do. Prepaid cards also tend to charge excessive fees when you reload the card, withdraw cash or pay your bills online.
Building credit with a secured credit card isn’t difficult. All you need to do is make one or two transactions on it every month, pay off the balance when the bill comes and watch your credit score rise.
Here’s an easy way to use a secured card responsibly: pick a recurring monthly bill that doesn’t make up more than 30% of your credit limit and put it on the secured card. As long as you don’t use the card for anything else, this will keep you consistently under the 30% credit utilization limit needed to improve your credit score.
For example, if you have a $200 credit limit and your monthly cell phone bill is $50 a month, that’s below the 30% mark. Pay your cell phone bill with the secured card every month and wait for the billing statement to be issued. Then, pay the secured card bill.
After a few months of paying your bills on time, the credit card issuer may automatically offer you a traditional credit card and return your deposit to you. You can also call and ask them to convert the card to a normal one. Depending on your previous credit history, this may only take a few months.
Once you get a normal credit card, continue the same pattern. Pay a few bills with it, wait for the statement to come and then pay off the total balance.
To see if the secured card is working, check your credit score once a month. You can find your credit score for free through your Mint account, and you can request a free copy of your credit report from each of the three credit bureaus – Equifax, Experian and TransUnion – through AnnualCreditReport.com. You’re entitled to a free copy of your credit report once a year, so most experts recommend checking your credit report every quarter with one of the three credit bureaus.
Some secured credit cards provide a free credit score as a special feature, including Capital One and First National Bank.
How to Compare Secured Cards
Like normal credit cards, every secured credit card has its own fees, interest rates and perks. Here are the criteria to use when comparing different secured cards.
Interest rate or APR
Each card has a unique interest rate or APR that can vary depending on your credit history. Secured cards usually have higher APRs than traditional credit cards. The interest rate only matters if you don’t pay off the entire balance when it’s due, so ignore this if you’re a responsible borrower.
Some secured cards will charge you a nonrefundable annual fee, ranging from $29 to $99. Not every card has an annual fee, so if possible you should apply for ones that don’t.
Each card has its own schedule, but most fees are between $25 and $35. You can avoid these easily by paying on time every month or setting up auto-pay.
Cash-back or other rewards
Almost every credit card these days offers cash-back or points when you use the card. It’s less common for a secured card to provide perks, but a few offer cash-back, like Discover it® Secured. Most secured cards at least give free travel accident insurance, rental car coverage and fraud protection.
Foreign transaction fees
If you love to travel, you probably know that using a credit card abroad can result in unnecessary fees. Before you sign up for a secured card, check their policy on foreign transaction fees. Most charge the standard 3% foreign transaction fee, but a few, like Discover it® Secured, don’t.
The required security deposit is unique for each card. Most ask that you put down an amount equal to the credit limit, but some cards give you the option of putting down less. This special option is only available if you don’t have a terrible credit history. The security deposit will be returned when you close the account, unless you’re behind on payments.
The credit limit on secured cards is generally low, usually with a max of $200 to $300. There are exceptions to the rule, such as the First National Bank Secured Visa® Card with a $5,000 credit cap.