Poor credit score? No credit score? We’ve all been there some time or another.
Say you’re interested in getting your first car. Or your first house. Your credit score plays a significant factor in these decisions. And a difference of just 25 points could save you tens of thousands of dollars. Moreover, a low score can make it impossible to get approved.
You might want to work on building your credit score. However, the task can be daunting. Getting a credit card is one of the best ways to improve your score. But if you can’t get approved for one because of your score, then how can you even work on your credit score?
Here arrives the secured credit card. Lenders are more likely to offer secured credit cards since they are much less risky than normal cards. Getting a secured credit card helps kickstart your credit-building journey.
What Is A Secured Credit Card?
A secured credit card is a credit card protected by a deposit. This deposit acts as the “collateral,” protecting the lender from any risks that you don’t repay your card.
For example, say you open a secured credit card and deposit $500 towards your account. Your lender will let you spend up to $500 on your credit card. Say you end up spending up to $500 of your limit and now can’t pay the lender back. The lender essentially hasn’t lost any money since you paid $500 beforehand.
Since secured credit cards are basically no risk for lenders, they are usually willing to issue them for anyone. Even as someone with poor to no credit history, you’ll likely be able to open one.
If you show good repayment habits with your secured card, you’ll eventually graduate into a standard credit card and get your initial deposit back. This deposit simply serves to protect the lender until you either (1) graduate or (2) close your card. In both cases, you’ll get your money back.
However, if you fail to repay your secured credit card, you won’t be getting that deposit back.
Why Are Secured Credit Cards Useful?
Remember that credit cards are one of the best ways to start building your credit score. By getting a credit card, you can possess good repayment habits, increase your total credit limit, and improve your credit mix. These factors all help to improve your score.
Secured credit cards are so useful because they allow anyone to get back on their feet even if they have a poor credit score. Since lenders face virtually no risk in giving these cards out, it’s really in your hands to use them wisely.
You control your destiny once you get your first secured credit card. They are the first steps you take in setting your credit score in the right direction for the future.
Secured Credit Cards Vs. Unsecured Credit Cards
The main difference between the two is the collateral. You don’t need a deposit to open an unsecured credit card. However, secured credit cards require some initial investment to begin. Simply put, unsecured credit cards are your typical, run of the mill standard credit cards.
The reason comes down to risk. The higher your credit score, the less likely you are to default on your credit cards. Thus, lenders are more likely to approve top of the line credit cards for those with good or excellent credit.
However, with a poor credit score, lenders fear you might not pay back the money you owe. Thus, they’re not as likely to approve you for a standard card. Instead, they’d like to minimize their risk by approving you for a secured credit card instead.
Broadly speaking, secured credit cards are for those with poor to no credit history. Unsecured cards are for those with good to excellent credit.
Other differences between them are that secured cards almost always have fewer perks than unsecured cards. Some of these standard credit cards even offer 5% cashback for your purchases or free flights. You won’t get any of these fantastic benefits with a secured credit card.
Unsecured credit cards are worth the effort.
Secured Credit Cards Vs. Debit Cards
If you know how debit cards work, they should sound eerily similar to secured credit cards.
In brief, a debit card is just cash in the form of a plastic card. For a debit card, you can only spend up to the amount of money you’ve deposited into your checking account. Similarly, for a secured credit card, you can only use up to the amount you’ve placed into your account beforehand.
So, if they work the same in principles, what differs?
The primary thing you need to remember is that secured credit cards can help improve your credit score. Your debit card doesn’t influence your credit score. Remember that when you use your credit card, you’ll still have to make monthly repayments. These behaviors factor heavily in your credit score.
In fact, timely payments take up 35% of your FICO Score 8 calculations. Maintaining good habits with your secured credit card can help your credit score over time.
Who Are Secured Credit Cards Best For?
Secured credit cards are best for those with poor to no credit history. Remember that lenders are willing to approve secured credit cards for even those with little credit history.
If you’re looking to start your credit score rebuilding journey, secured credit cards are one of the best ways to begin.
Wait—Why Is My Credit Score So Important Again?
Your credit score plays a critical role in deciding your approval odds and interest rates. For example, a minor 25 point credit score boost could save you thousands of dollars on your mortgage.
Let’s glance at the table below, showcasing the average fixed interest rates for a 30-year $100,000 mortgage at different credit scores.
|30-Year Fixed Rate $100k Loan (7/7/2020)|
|FICO Score||APR||Monthly Payment||Total Interest Paid On Loan|
As we can see, bumping your credit score up just 25 points from 640-659 to 660-679 could save you thousands of dollars. That’s a lot of savings! And a pretty small improvement overall.
Now, say you worked hard and pushed your score up somewhere to 760-850. This move alone could save you about $20,000.
Does this logic apply to credit cards? Absolutely.
Credit card issuers will award the best credit cards to those with top credit scores. These amazing credit cards can grant you free gift cards, hotel stays, and even flights. However, you’ll never be able to tap into these excellent benefits with a poor credit score.
Also, a low credit score makes it challenging to get approved for a mortgage, auto loan, and more. It might even make it difficult to rent an apartment. Thus, monitoring and improving your credit score is vital.
You can start building your credit score with a secured credit card today!
Best Secured Credit Cards
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Frequently Asked Questions
Yes and no. If you show good repayment habits and are promoted to an unsecured (regular) credit card, you’ll get your security deposit back. However, if you fail to repay what you’ve spent, then the lender will take your deposit to cover their losses.
Absolutely not. There’s a variety of methods you can start applying to improve your credit score to good or even excellent territory.
For example, checking your credit report for errors is probably the first step you need to take to improve your credit score. Paying off your credit cards is also a fantastic way to raise your score quickly. Moreover, credit score boosting tools like Experian Boost can also help you in some circumstances.
The takeaway? Secured cards are one of the many good ways to help you achieve your credit score goals.
In a nutshell, a soft inquiry won’t hurt your credit score, but a hard inquiry could.
Soft pulls are like a brief snapshot of your credit history, but a hard pull analyzes every pixel. A hard inquiry could hurt your credit score. Though, hard inquiries only last 24 months on your credit report and play a small part in credit score calculations.
Closing a credit card is not an easy task. In fact, bringing scissors to this piece of plastic will likely hurt your score.
Your credit utilization ratio will increase. The higher your ratio, the lower your score. Secondly, your average account age will decrease, which is also factored into your credit score. Closing any accounts will reduce your score or do nothing, but cannot help your score.
Closing an account should be thought out very carefully, considering there are many adverse effects on your credit score.
John Ta is an undergrad at the University of Pennsylvania and the founder of Penn’s first undergrad personal finance club, Penn Common Cents. As a first-generation college student, he had to learn everything about personal finance on his own and seeks to mend the financial literacy knowledge gap seen almost everywhere. John is currently studying for an MS in Chemistry and a BA in Physics (business & tech concentration), Biochemistry, and Biophysics and is interested in the intersections of finance and healthcare.