Using a Secured Credit Card To Build Credit

Introduction

It’s not uncommon for young adults starting out, immigrants from another country, or people who typically rely on cash to find themselves with little to no credit history. And that makes it almost impossible to get approved for a traditional credit card.

Trying to build — or rebuild — your credit can be tough if you don’t already have credit. Most creditors want to see that you’ve properly managed credit in the past before granting you a credit card now. But how are you supposed to demonstrate your amazing credit-usage skills if you don’t have any credit to use?

If you find yourself in this apparent catch-22, a secured credit card might be your way forward.

What Is a Secured Credit Card?

Credit cards and loans come in two basic types — secured and unsecured. Secured credit requires some type of collateral that the lender can seize or keep if you default on the loan. Unsecured credit relies on a solid track record of paying back what you borrow. Your word, in the form of a promise to pay, is the lender’s only assurance.

A secured credit card requires collateral, and in this case it’s a refundable deposit that you provide to the creditor. The specifics may vary, depending on the issuer and your credit history, if you have one. But the amount of the deposit is often the same as the credit card’s limit — for example, a $200 deposit gets you a $200 credit line.

A common misconception is that the deposit makes your secured credit card more like a debit or prepaid card, and you’re spending your own money. You’re not. The deposit is simply there in case you end up not sticking to your part of the agreement.

This collateral makes you less risky to the lender, so even people with low or no credit scores can usually get a secured credit card — as long as they can afford the required security deposit and any associated fees.

Of course, that can be a sticking point for many people. It might not seem logical to pay for a low-limit credit card when you could just spend that money. But keeping the cash doesn’t give you a means of building credit. The value might become clearer if you look at the collateral as an investment in your future rather than an expense. 

Unsecured vs Secured Credit Cards

When people talk about a “credit card,” they’re most often referring to an unsecured credit card. These standard or traditional credit cards are typically issued based on your credit score and the information in your credit reports. If a creditor decides you’re a suitable risk, they may approve you for one of their credit cards.

Because they don’t require collateral, the lender may not be reimbursed if you pay late or default on what you owe. That’s why the best offers are usually reserved for people who have established good credit management patterns in the past. This also makes unsecured cards harder to qualify for, with more rigorous screening for applicants.

Beyond these key differences, secured and unsecured credit cards are quite similar. They both offer a pre-determined amount of credit, otherwise known as a credit limit or credit line. Both may provide rewards programs and other benefits. And both may charge various fees and interest on outstanding balances, while typically requiring you to pay at least a minimum amount every month.

Both can also help establish and build your credit history. Whether that history is positive or negative largely depends on your payment and spending habits rather than the card type itself.

How Does a Secured Credit Card Work?

You apply for a secured credit card by submitting an application form, just like with an unsecured card. If you’re accepted, you’ll make your refundable deposit to the credit card issuer. That’s the only part of the process that differs significantly between the two types of credit card.

From that point forward, a secured credit card works like any other credit card. You make purchases with the card, you receive a statement at the end of each billing cycle, and then it’s up to you to make at least your minimum payment by the due date each month.

Just like with an unsecured credit card, a secured credit card issuer will usually report your account activity to one or more of the three main credit bureaus. This reporting is what helps a secured cardholder build credit.

Establishing a positive credit history can take anywhere from six to 18 months of on-time payments, and sometimes even longer. After that, your card may be upgraded to unsecured. Or if the creditor doesn’t offer that option, your secured card may be canceled, and you can then apply for an unsecured card. Either way, your security deposit should be returned to you at that point, and sometimes with interest.

However, if you miss those payments or default on the debt, the creditor may keep your deposit instead of returning it. That’s what collateral is for, so it’s important to be aware of that possibility and remain diligent with the card.

What Should I Look For in a Secured Credit Card?

Secured cards might seem pretty basic, but the features and benefits can vary. If you’re only getting one secured card, choosing what works best for you is a big decision.

• Interest rates: Look for the lowest annual percentage rate (APR) available to you. This will usually only be in play if you carry a balance, but it’s a good idea to be prepared.   

• Additional fees: Some cards come with annual fees, or other charges like transaction fees. Make sure your chosen card makes sense financially for how you’ll use it. 

• Credit reporting: Most secured credit cards will report your activity to the major credit bureaus, since that’s one of the main benefits — but it’s not guaranteed. Double check that the card you’re going to apply for does. 

• Rewards and benefits: Rewards like cash back on your most common purchases make a credit card more appealing. Free credit score access and other perks are useful as well. Not all secured cards include these types of benefits, so try to choose one that aligns with your spending patterns and needs. 

• Reliable provider: If you’ve never heard of the bank or financial institution offering the card, think twice or do some research. Make sure it’s a credible financial services company with available customer service.

How Do I Get a Secured Credit Card?

The process for getting a secured card is relatively straightforward.

1. Shop around and compare your options. Since secured cards vary quite a bit, start by researching what’s available. You’ll want to evaluate the fees, interest rate, credit reporting opportunities, and what rewards or other benefits are included. 

2. Submit an application. Like most credit applications, the form to apply for a secured card will usually ask for personal details like your name, address, Social Security number, and monthly income. 

3. Wait for approval. The bank will review your application and make the decision on whether to approve you for the card. They’ll usually notify you of the required deposit when sending the approval notice, which may or may not be immediate. 

4. Make a security deposit. You might be given a choice of how much to deposit as collateral, or it could be a predetermined dollar figure. But your deposit amount will often equate to the card’s credit limit.

If you later want to close out the credit card and your account is in good standing at the time, you can usually receive a refund of your security deposit. 

How To Increase the Limit on a Secured Credit Card

It’s not always possible to increase your credit limit on a secured credit card. It all depends on the contract details and your account standing.

The fastest way to know for sure is to check your cardholder’s agreement. It should clearly state whether or not increasing the limit is allowed, and outline the steps you need to take if it’s possible. You may have to deposit more money as collateral for the higher credit line, or you might be eligible for an automatic increase after a certain number of on-time payments. 

How To Use a Secured Credit Card to Your Advantage

Having a secured card is one thing, but maximizing the positive impact on your credit score requires some strategy and consistency. 

Focus on a positive payment history

Your payment history is the biggest factor in calculating your credit score, and using a secured credit card to help you build a positive track record is one of the main reasons to get one. So you’ll want to make your payments on time, every time.

That means paying at least the minimum amount due by the payment due date each and every month. If the payment is late, or for less than the minimum, it could result in a late fee or end up as a negative mark on your credit report.

A great way to make sure your payments arrive on time is to set up AutoPay for at least the minimum. If that’s not an option, you can turn on automatic payment reminders through your credit card’s mobile app or put the due date in your calendar.

Keep your credit utilization low

Your credit utilization ratio is a measurement of how much available credit you’re currently using, and it can be calculated on both individual accounts and across all your credit balances. This is another important part of credit score calculation, and experts recommend keeping that number at 30% or less if you want to positively influence your credit score.

So if your secured credit card is your only revolving credit account and has a limit of $300, that would mean keeping a balance of $100 or less. This might seem ridiculously low at first, but think of your card as a tool for building credit more than a means for making purchases. Spending small amounts and then paying them off each month is one of the fastest ways to build that history of steady, on-time payments.

Work towards graduation day

A secured credit card isn’t meant to be used forever — it’s a stepping stone to other credit options. Some creditors may automatically switch your account or offer you an unsecured card once they feel you’ve proven yourself. Or you could reach out and ask them about graduating to an unsecured credit card.

And you’ll quite likely find yourself being pre-approved for different offers from other companies as well. Of course, you’re welcome to apply for other credit cards at any time, but waiting to improve your credit score with your secured card first can increase your chances of approval and potentially lead to better rates and terms.

Keep in mind that every time you apply for a credit card, the card issuer does a hard inquiry into your credit report, which could lower your credit score by about five to ten points. Checking to see if you pre-qualify first can prevent unnecessary hard pulls and give you an idea of your chances through a soft inquiry, which doesn’t impact your credit unless you submit the full application.

Cons of Secured Credit Cards

You already know the pros of secured credit cards — you can often get one even with limited credit history, and it can help you build your credit to the point of qualifying for unsecured offers, higher credit limits, lower rates, and better terms. But they also come with some drawbacks worth considering.

They require a deposit as collateral

It might be only a few hundred dollars, but having a lower credit score often comes with limited funds as well. So scraping together that security deposit and leaving it with the creditor for a year or more can be painful.

The credit limit is often quite low

Because it’s tied to your collateral, secured cards often come with a relatively low credit limit, like $200 or $300. That’s enough to build credit, but it’s not always enough to make significant purchases. And that low limit makes it very easy to end up with a high credit utilization ratio if you’re not careful.

They may have higher interest or fees

Some secured cards have an APR in line with unsecured cards, but others may be significantly higher. They also might come with higher annual fees, transaction fees, or penalty fees that other credit lines don’t have. On the other hand, it’s not unusual to see a $0 annual fee for a secured card.

Rewards and benefits may be less appealing

The biggest benefit is building credit, and that may be enough. However, additional perks like rewards are often smaller than with unsecured cards, or even non-existent. 

How Much Will a Secured Credit Card Raise My Score?

Credit scores typically range from 300 to 850, so there’s a wide spectrum. And there’s no simple answer for how much a secured card will raise (or lower) your score. If you’re starting with little to no credit history, there’s nowhere to really go but up, so there’s a good chance you’ll see positive movement.

But if you’re fighting an uphill battle against existing debt and poor credit history, the rise in your score may be more modest or slow. You’ll typically see the best outcomes if you intentionally use your card with a strategic goal in mind. 

How Fast Does a Secured Credit Card Build Credit?

The time it takes to build credit with a secured card can vary. You may start to see changes in your credit score within six months of opening the credit card. But significant improvement to a poor credit score can take several years or more. The speed is affected by many factors, including the details of any negative items on your credit report. 

A secured card might not be your first choice for credit. But if it’s the only type of credit card you can get, it can be an invaluable tool for helping you establish or reestablish a positive credit history. And if you use it strategically and responsibly, you can hopefully graduate or move on to an unsecured card in the future.

FAQs About Secured Credit Cards

How much should I deposit for a secured credit card?

You may not have a choice in the matter, but if you do, it’s important to pick an amount that works for you. Expect the money to be held for a few years, and don’t put down more than you can afford.

The amount of the credit line doesn’t matter as much as what you do with it. Even a small credit limit gives you the opportunity to make purchases and pay them off in a timely manner.

Can I graduate from a secured card to an unsecured card?

In many cases yes, the creditor will give you the opportunity to graduate to an unsecured card after you’ve established an adequate credit history with the secured card.

If that’s not part of the arrangement on your secured card, you can still look for unsecured credit cards that fit your credit profile — either through the same creditor or a different one. Seeing if you pre-qualify before applying can prevent unnecessary hard pulls.

What happens if I miss a payment on my secured credit card?

If you miss a payment with any credit card, secured or unsecured, it may appear as a negative line item on your credit report. And that can remain there for up to 7 years, which negates the positive motion you’ve achieved with the secured card.

Keep in mind that late payments occur when you have not paid at least the minimum amount due by the due date. Those will often be assessed a late payment fee, but they may not be reported to a credit bureau. Missed payments remain unpaid by the next billing cycle, around 30 days later, and those are often reported.

What credit score improvements can I expect with a secured credit card?

Credit scores are somewhat mysterious with complicated algorithms, so there’s no black-and-white answer for how your credit score will or won’t be affected.

However, regular on-time payments typically go a long way toward building a positive credit history. Combining this practice with relatively low utilization usually results in a higher credit score. 

Can I increase my credit limit on a secured credit card?

Some secured credit cards just stay at the beginning level for the duration, but others may allow you to increase the credit limit. That might involve paying more into the security deposit to match your new credit line, but some cards give an automatic credit limit increase after a certain number of on-time payments.

If in doubt about the parameters of your credit card, you can usually find the answers in your cardholder agreement. And if you don’t see what you’re looking for, you can call customer service and ask.

Bottom Line

Secured credit cards can be a great credit-building strategy for those with limited or non-existent credit profiles. It provides a means to build a positive credit history even when other forms of credit are out of reach.

If you’d like to add a secured card to your credit-building toolbox, see if you pre-qualify before submitting the application.