How does a secured credit card work?

master card and blue jeans

Secured credit cards serve a very important purpose to those who have them.

First of all, they help establish a good credit history.

This is especially useful if you’ve immigrated to the US or have gone through a divorce, since your credit in those cases will probably be nonexistent or extremely damaged at least.

Secured credit cards are designed to help you get over these problems by restricting the amount you can spend monthly with the credit card. This is done by tying the credit limit of your secured credit card to a deposit, rather than a credit history.

Having a good credit score is something every one of us strives to achieve, but once we get into a vicious cycle, like in the cases I mentioned earlier, it is very hard to have a credit history at all.

Here’s where secured credit cards come into play.

Unlike traditional credit cards, you’re credit history is irrelevant.

However, the thing that needs to be mentioned here is that the deposit you put down for your secured credit card.

One of the best ways to understand what secured credit cards are and how secured credit cards work is by comparing them to the traditional credit card.

Unsecured credit cards vs. secured credit cards

An unsecured credit card is based on the credit history of the credit card holder. If the holder has a good credit history, the traditional credit card uses this information as a kind of security.

There is a misconception with unsecured credit cards which states that these cards are not really backed by anything. On the contrary, the banks know exactly what they’re doing by tying the unsecured credit card to your credit history.

This means that the banks get more profit, although you may start falling behind with your payments.

Of course, if that happens, your credit score will be damaged and no one wants that to happen to them.

Now, if you don’t have the necessary credit history to get a credit card, but do have the money to afford a credit card, you can get a secured one.

The real difference with secured credit cards is that you have to put down a deposit which will give you the incentive to not fall behind with your payments and interest costs of your credit card.

If that happens, not only do you have to pay the credit card debt you owe, but you also lose the deposit you put down for your secured credit card.

The deposit is, basically, a substitute for your credit history. It is not only there as a kind of security to keep you going with your payments, it also determines and affects other things, just like traditional credit cards do.

Credit limits of secured credit cards

With traditional credit cards, your credit card limit is determined by your credit history. If you have a good credit history, your credit limits are much higher than with a bad credit. Your credit history is determined by many factors, but mostly it has to do with meeting payment deadlines for your monthly credit card costs.

If everything is neatly paid month in, month out, then your credit history will be in good standing and can help you get a higher credit card limit.

With secured credit cards, as we said before, the deposit is the substitute for your credit history. The more you put down as a deposit, the higher the credit limit of your secured credit card will be.

The credit limit with secured credit cards is often 50% and can be up to 100% of your security deposit for the given secured credit card.

However, some credit card companies accept other forms of deposit. Instead of cash, you can put your house, car or other valuables as the deposit, if you find a credit card company that does that.

However, why would you go through all of this if you have the money already you want to spend, but put it down as security deposit instead?

What are secured credit cards good for?

As we said in the beginning, secured credit cards are a great way to establish a credit history or to repair a damaged one from before. If you need a credit card, and don’t have the necessary credit history but do have the income, then a secured credit card is just the thing you need.

Building credit with your secured credit card is simple. All you have to do is pay your credit card fees and costs regularly and watch the credit history build itself up. Your credit report may take a few months before it starts showing the usage of your secured credit card, but once it does, you can be sure that you’re on the right path.

Be prepared for higher fees

One of the downsides of secured credit cards is that they have higher fees than traditional credit cards. This happens because the company issuing the secured credit card takes on a much higher risk than with traditional credit cards. It is very important to carefully read the contract for secured credit cards, as the higher fees may not be foreseen by you if you don’t know what they entail.

Conclusion

Let’s sum it up.

Secured credit cards are great for people who have damaged credit scores, but are eager and have the necessary income to meet all of the costs a credit card entails. If you’re looking to build up you’re damaged credit history, then a secured credit card is the way to go. However, be aware of the higher fees these kinds of cards have.

Furthermore, once you build up your credit history and have the necessary credit score to get a traditional credit card, you should consider switching to it, since the fees are much more manageable and maybe you can get a much better deal in terms of credit card limits.