The Pros and Cons of Secured Credit Cards
Secured credit cards require an upfront security deposit that acts as collateral for the line of credit. The deposit helps those with poor or limited credit get approved and build their credit scores. However, secured cards have both advantages and disadvantages to consider before applying.
How Secured Credit Cards Work
Secured cards function just like regular credit cards for making purchases and payments. The key difference is the cash deposit the issuing bank holds as security for the account. This allows lenders to extend credit to high-risk applicants.
Your deposit amount becomes your initial credit limit. The bank reports your monthly payment activity to the three major credit bureaus to help establish your credit profile.
After demonstrating responsible usage for several months, the card issuer may graduate you to an unsecured card and refund the deposit. Secured cards can be an important step in rebuilding credit.
The Pros of Secured Credit Cards
Here are some of the main benefits that secured cards offer:
1. Easier Approval Odds
Poor credit or a limited history often results in credit card denial. Secured card issuers are more likely to approve applicants since the deposit protects them against the risk of non-payment. This provides access to credit cards that would otherwise be unavailable.
2. Opportunity to Build Credit
Most secured card issuers report your monthly payment activity to Equifax, Experian, and TransUnion. This helps establish a positive credit history confirming your ability to manage credit and make timely payments.
3. Chance to Rebuild Credit
If you have bad credit due to past mistakes, responsible secured card usage provides a way to gradually restore your creditworthiness. On-time payments contribute to rebuilding your credit scores.
4. Potential to Graduate
After consistently making your monthly payments on time for around 7-12 months, the secured card issuer may review your account for graduation to an unsecured card. At this point they refund the security deposit.
5. Use of Card Benefits
Secured cards provide access to open credit and benefits not available with debit cards or prepaid cards, like fraud protection, rewards points, and building credit history. Using your card responsibly allows you to enjoy these advantages.
The Cons of Secured Credit Cards
Set against the benefits are a few potential drawbacks:
1. Upfront Deposit Requirement
The main disadvantage is the upfront security deposit equal to the credit limit you are approved for. For those with limited funds, coming up with $200 to $500 or more can be challenging. However, some cards have low minimum deposits.
2. Deposit is Inaccessible During Card Use
The funds you deposit as collateral remain locked in a secured account until you close the card. This ties up money that could otherwise earn interest or invest somewhere else. Avoid using emergency savings for the deposit if possible.
3. Potential Added Fees
Watch out for secured cards that charge expensive annual fees, application fees, or maintenance fees. These add to the cost. Try to find options with no annual fee and look for hidden charges.
4. Possibility You May Not Graduate
There is a chance your secured card issuer may never graduate your account to an unsecured card, or the graduation process could take a very long time. Make sure to understand any graduation criteria before applying.
5. Lower Credit Limits
Secured cards tend to have relatively low credit limits ranging from $200 to $500 for starter cards. While this minimizes the deposit amount, it restricts the spending power and credit utilization compared to unsecured cards.
Pros and Cons of Using Secured Cards to Build Credit
Specifically for the purpose of building credit, secured cards offer a mix of advantages and drawbacks:
Pros for Building Credit
- Get access to open credit not available otherwise
- Make monthly on-time payments reported to credit bureaus
- Demonstrate responsible credit management
- Increase credit scores gradually over time
Cons for Building Credit
- Requires a refundable security deposit
- Slower process than becoming authorized user
- Lower maximum credit limits than unsecured cards
- Must wait 7-12 months for possible graduation
Overall, the ability to build credit history and improve scores over time generally outweighs drawbacks of deposit requirements and low limits for those unable to qualify for other unsecured cards.
Alternatives to Secured Cards
Other options exist besides secured cards to access credit and build history:
- Credit builder loans – Installment loans that report monthly payments
- Authorized user status – Get added to a family member’s credit card
- Student credit cards – Starter cards for those enrolled in higher education
- Retail store cards – Store-specific credit cards with lower requirements
However, secured cards remain the only option that allows access to open revolving credit without requiring an existing credit history. The deposit provides unique access and approval odds.
Evaluating if a Secured Card is Right for You
When weighing applying for a secured card, ask yourself:
- Do I have a deposit amount saved that I can commit for 6-12 months?
- Will I avoid carrying balances and pay the bill in full monthly?
- Do I have limited or poor credit with no unsecured card options?
- Am I comfortable waiting for possible graduation to unsecured?
- Are there hidden fees or charges with this card?
If you can answer “yes” to these questions, the benefits likely outweigh the drawbacks in your situation. Proceed with a secured card application.
Key Takeaways on Secured Card Pros and Cons
- The upfront deposit requirement can be a challenge, but provides access to credit otherwise unavailable.
- Make sure your card reports to credit bureaus and offers potential graduation to build scores.
- Be prepared for a 6-12 month commitment before getting your deposit back when graduating.
- Compare fees and terms across multiple secured card offers to find the best fit.
- Weigh alternatives like credit builder loans or authorized user status based on your needs.
- Use responsibly and a secured card can be an important step in establishing or rebuilding credit.
The pros of secured cards tend to outweigh cons for those with limited options. But be sure to choose the right card and use properly to maximize the benefits while minimizing drawbacks.