“What is a secured credit card?” you may ask. Secured credit cards really aren't that complicated. They're different from a traditional credit card in that they require a cash deposit. This deposit will work as your available credit. So if you put down a $500 cash deposit, you’ll probably have a $500 credit limit.
Then you can use your secured credit card like a regular one and pay it off each month. If you don’t have a credit history — or don't have a good one — your deposit serves as collateral in case you default on payments. In other words, if you stop making payments, the card issuer will keep your deposit.
If you’re working to build your credit, a secured credit card is a good tool to have in your arsenal. In fact, 32 percent of card users own a secured credit card, according to an Experian survey. Here’s how two people used secured credit cards to their advantage:
What Does It Mean to Build Credit?
The term “build your credit” means that you're trying to improve your credit score. This score, which is determined by your payment history, outstanding balances, length of credit history, applications for new credit accounts, and types of credit accounts, lets creditors know whether or not you have a high or low credit risk.
A higher credit score typically makes it easier to qualify for loans, lower insurance rates, or qualify to rent homes or apartments. You can view your annual credit report on AnnualCreditReport.com, or through any of the three major credit agencies: Equifax, Experian, and TransUnion.
Credit scores range from 300 to 850, but anything over a 700 is considered good, according to Experian. Anything over 800 is an excellent score, and generally considered the ideal.
While there are many ways to build (or rebuild) credit, some people have turned to using secured credit cards as a simple way to improve their credit scores.
Using a Secured Credit Card to Build Credit
Christine Wong, a real estate agent in Los Angeles, wanted to establish her credit when she started college, so she got a secured credit card from Wells Fargo, backed by a $300 deposit. After opening the account and using the card responsibly, she was able to build her credit.
“Being disciplined and paying off the small balance every month contributed to a great credit score of 767 after 18 months,” Wong says.
A secured credit card put her nonexistent credit on the map and, over time, resulted in an excellent credit score.
Jacob Johnson’s Story
Jacob Brad Johnson studied financial planning in college but felt like a hypocrite because he didn’t have a credit score. After some research, he decided to get a secured credit card. “I chose this kind of card because I didn't have many other options,” he says. “Secured credit cards are easy because almost anyone will give you one.”
At the age of 22, Johnson got his secured credit card from Capital One. It has a $200 credit limit and required just a $50 deposit. Within two months, he established a credit score. It started at 636, but within a year, it has increased to 740.
Johnson recommends secured credit cards as a good option for anyone, especially college students.
How to Build Credit With a Secured Credit Card
If you opt to use a secured credit card to establish credit, it’s important that you make payments on time and in full.
Your goal is to build your credit, and payment history is the most important part of that. Plus, you want to keep your balances low, as your credit utilization matters. If you’re using your entire line of credit, it could be a warning sign to the lender.
Spend less than 30 percent of your credit limit and pay off the full balance on time each month.
Following these two rules will help you build credit. After a year or two, you may be able to graduate to an unsecured credit card. Of course, you want to make sure that your credit is good enough at that point for you to get approved, so it doesn’t hurt to check your credit score first.
You can also call your secured card issuer to see if it’s possible to switch to an unsecured card. When you do get an unsecured credit card, you can close your secured account and get your deposit as long as you’re in good standing with your payments.
The Bottom Line
A secured credit card can be a great way to establish and build credit if your credit history is nonexistent. You must make sure you have the cash on hand for the deposit and know that you can pay the balances in full and on time.
Using the card responsibly can help produce a credit score so that other doors open to you, like that dream apartment or a car loan.