I have often heard people say that having a secured credit card or loan can hurt your credit. This is a myth that needs to be dispelled.
The only way a secure credit card can hurt your credit is if your payment history is not being reported. If you have wondered whether having an unsecured card compared with a secured card affects your score, it does not. A card may not even show up as a secured card on your credit history. Making payments in full and on time will help your credit score.
Secured Credit Cards Do Help Your Credit Score
I get this question a lot, “How does a secured credit card affect my credit score?” A secured card can help your credit score just as much as any unsecured card. It is important to know that you can use secured cards to establish a good payment history, keep your utilization ratio low and begin a credit file. You will not get a lower credit score for using a secured card. Banks and lenders want to see you’re capable of handling all types of credit. Not just credit cards.
You may want to get a secured card if you have no credit history or have a poor credit history. Basically, if you can’t get any other kind of credit card, this is how you can move your credit score up. In the long run, it will depend on how you manage the card.
What Is a Secured Credit Card?
Secured credit cards require a deposit that serves as collateral for purchases you make using the card. If you stop making your payments, the card issuer keeps your deposit. You must keep your account in good standing until your credit card issuer returns your funds. You will not be able to access those funds without closing your account or when you have had the card for a certain number of months they release the funds.
Even though a secured credit card makes you give them a security deposit for a credit limit, you can use the secured credit card just like you’d use any other credit card. You can swipe it for any purchases up to your credit limit as long as you are making timely payments each month.
Your Credit and How a Secured Card Works
Remember, not all secured credit card issuers report your good behavior one of the three credit bureaus. When you’re comparing secured cards, look for issuers that report to one of the three credit bureaus so you are not wasting your time.
The following ratios impact your FICO credit score:
- Credit mix (10%)
- Inquiries (10%)
- Length of credit history (15%)
- Utilization ratio (30%)
- Payment history (35%)
How High Can the Limit Get on a Secured Card?
The limits on secured cards typically aren’t very high, but it’s possible to find some that go to $10,000. On the other end of the spectrum, the minimum is usually $200. Whatever the limit is, that is normally the amount of money you deposit as the issuer’s collateral. So, you’d put down $500 for a card with a limit of $500. Check each card issuer to see if it lets you make a larger deposit for a higher limit.
In some cases, your credit limit can be bigger than your security deposit, depending on the card you choose and your credit rating. The Capital One Secured Card, for example, allows some applicants to pay a $49 or $99 security deposit for a $200 credit limit.
Getting a higher limit may help raise your credit score because your credit utilization will be less affected. When you are rebuilding your credit you do not want your balances to exceed 10-30% of your credit limit. It can be difficult to purchase more than a tank of gas with a $200 credit limit.
Responsible Use of a Secured Card
Like with regular credit cards, many secured cards annual charge fees. However, it’s fairly easy to get a secured card that doesn’t charge fees. Doing your research and finding a card that doesn’t charge these types of fees can save you money in the long run.
We recommend that you pay off your card each month so you are not incurring interest charges and you are able to demonstrate responsible spending habits. You do have to consider interest rates unless you’re sure you’ll pay your balance in full each month. Interest charges add up and can make it more difficult to pay off your card balance when you’d like to transition to an unsecured card.
In any case, it’s important to research interest rates and fees. You can get fee-free secured cards from the issuers below:
- Navy Federal Credit Union
- Capital One
- TD Bank
Check out each issuer’s website to see if you qualify for a card. Or call your local banks and credit unions and see who is offering a secured card with no fees. Again, make sure you are only working with banks that report to all three bureaus.
The bottom line is that having a secured credit card will give you the access you need to available credit. Because you are putting up your own money to secure the credit line you will may be able get better rates with a secured card over an unsecured card that is meant for people with less than perfect credit. There is less risk to the bank when you have the confidence and resources to use your own money.
What Happens When You Default On A Secured Card?
If you miss a payment, it will generally be reported to the credit bureaus once it becomes 30 days past due. At that point, you will be charged a late fee and interest on your balance. Your credit score will also take a beating.
If you miss the next payment, and you’re reported as 60 days past due, your credit card interest rate may increase, you’ll be charged a late fee and interest, and your credit score will drop some more. At 90 days past due, all of the above happens, and the issuer may close your credit card.
Secured credit cards can help your credit, but as with any credit card, missing payments will hurt your credit instead. As soon as you think you can’t pay your credit card bill, reach out to your credit card issuer and make arrangements.
If an account is more than 120 days past due, the account is closed, and the security deposit will be applied to any outstanding balance. The remaining deposit amount, if any, will be refunded to the customer.
Drawbacks to Using Secured Credit
While secured credit cards can be appealing for those trying to improve their credit scores, there still are a few disadvantages.
- People often find it difficult when they are first starting out to come up with even a couple of hundred dollars to make a security deposit. If you do have that money, it might be better spent paying off some outstanding debt.
- There may be fees in addition to the deposit. Some cards as you to pay an application fee, or an annual fee to have your secured credit card. This is just another way of earning additional interest. It is called the “cost of credit” and it increases the cost of having the card. Shop around and select a card with the lowest fees.
- You may have to pay a higher interest rate but again shop around. If you are securing the card with the exact amount of the credit line there are cards with more competitive rates.
Overall, I recommend that you get a secured credit card if it means paying higher interest rates and annual fees for a credit card that is not secured. You will eventually get your money back and it is a good financial habit to have savings. You can leave your initial deposit in a savings account and have access to it for emergencies.