If you have a low credit score or no credit history, it can be difficult to get approved for a line of credit. One of the best ways to build up your credit score is to sign up for a secured credit card. Secured cards are a way to prove to a lender you can be responsible with credit.
How Secured Credit Cards Work
With a secured card, you have to put down a deposit with your own money. When you give the bank your deposit, they’ll issue you a line of credit that will most likely be equal to the amount you deposited. Sometimes, however, your secured card limit may be a bit higher than your deposit. Think of that deposit as collateral. If you stop making payments on your card, the bank will simply keep your deposit.
How Should I Use a Secured Card?
Your goal with the secured card is to demonstrate how responsible you can be. This will in turn improve your credit score. You should focus on (1) keeping your credit utilization low and (2) making full, on-time payments each month. Those two factors alone make up 60% of your credit score.
- Use the secured card. If you don’t use the card, it won’t improve your score by much. Charge a small amount to the card each month and pay it off in full. Aim to carry a balance that is no more than 20% of your available credit limit. That keeps your utilization low and will in turn help your score.
- Pay your balance in full each month. You can make sure you do this by signing up for automatic monthly payments. This also helps you avoid accruing interest by carrying a balance each month.
- Sign up for a credit monitoring service such as Credit Karma, Discover’s credit scorecard, or another service that lets you check your report monthly, for free. You can also get a free annual credit report from all three bureaus at AnnualCreditReport.com.
- Check your credit report monthly to make sure the bank is reporting your secured card behavior to the credit bureaus. If the bank doesn’t report your behavior to the bureaus, you’re missing out on the main benefit of having a secured card.
How Long Until I See Results?
No matter what your reason for using a secured card, you should understand that the credit-building process will be slow. It may take a year or longer to lift your score by 100 points.
Choosing the Right Secured Card
The secured card you choose will ultimately depend on a personal assessment of your fiscal habits and a careful review of the card’s terms. Your best bet will be to look for a card with no annual fee, a low minimum deposit, and the lowest annual percentage rate (APR).
What to Watch Out For
The Interest Rate
Interest rates on secured credit cards tend to be much higher than standard credit card rates. So long as you pay your statement balance in full and on time every month, the interest rate doesn’t matter. Your goal with a secured card is to build your score over time with responsible behavior, so the interest rate shouldn’t matter.
Find out how much you have to put down to get the limit that you want. Sometimes the deposit is only a fraction of the card’s credit limit. If you get a card with a limit that is higher than your deposit, have a heart-to-heart with yourself to be certain that you can manage the limit responsibly.
You’d also want to know how long the bank will keep your deposit after you close the secured card as it might not give it back to you right away. Some banks will keep the deposit to cover any charges to the card for a couple of months after you close the account.
Fees and Charges
Like credit cards, secured cards can also come loaded with hidden fees and other charges. These can eat away at your security deposit and your card limit if you’re not careful. The Consumer Financial Protection Bureau has a great example of a credit card agreement that highlights what you should look out for. A couple of the most important items to check are if the card has an annual fee and if it has a period after which the interest rate you’re paying will increase.
Most secured credit cards don’t offer any rewards, but a few, like the Discover it® Secured Card – No Annual Fee, let you earn rewards for your purchases. You shouldn’t focus solely on the perks when choosing a card, but they are nice to have.
There are a few reasons Discover is our top recommendation. First, there is no annual fee. Second, you get to see your credit score for free. And (most importantly), Discover starts automated monthly reviews of your account after 8 months to see if you can be transitioned to an account with no security deposit. Also, if you have previously filed bankruptcy, Discover will still consider your application.
Transitioning from Secured Card to Credit Card
After you demonstrate dependability by making full, consistent, on-time payments for a given amount of time — usually about a year or so — your credit score should have improved greatly.
Once you are ready to move on from the secured card, you can close your account and you will be given back your security deposit.
You’ll likely be in a position at that time to apply for a regular credit card. You can apply for a regular card with the same bank that issued your secured card, but you don’t have to.
There’s a decent chance that the bank will want to keep you as a customer and may offer to upgrade your secured card to a regular credit card. But in some cases you’ll have to ask for an upgrade.