A credit score is a crucial factor in determining one’s financial health. It can determine if you are approved for a loan, apartment, or job. However, approximately 26 million Americans have no credit history, making it difficult for them to establish their creditworthiness. Without a credit history, it is challenging to obtain credit cards, loans, or mortgages. Fortunately, secured credit cards are a great option for building or rebuilding credit. Before you get one though, our credit counseling advice is to make sure you understand how they work. Let’s explore secured credit cards and how they can help individuals establish their credit history.
What are Secured Credit Cards?
A secured credit card is a type of credit card that requires an initial security deposit before use. Typically, the security deposit ranges from $200 to $2,500, and the credit limit is equal to the deposit. For example, if you put down a $500 security deposit, your credit limit would be $500. The deposit acts as collateral for the lender in case the cardholder defaults on payments. It is typically held in a separate account, and the cardholder cannot access the funds until the card is closed or upgraded to an unsecured credit card.
Other than the security deposit, secured credit cards work just like regular unsecured credit cards. Cardholders can use the card to make purchases and pay bills, and they will receive a monthly statement detailing their transactions and balance. However, these credit cards typically have higher interest rates and lower credit limits compared to unsecured credit cards.
Who Uses Them?
Individuals with little to no credit history are the primary users of secured credit cards. They are a great starting point for establishing credit history because they report to credit bureaus just like regular credit cards. Additionally, those who are rebuilding their credit history after struggling with consumer debt can also use secured credit cards to get back on track. It’s like training wheels for credit. For example, a teenager or someone who has filed for bankruptcy may benefit from using a secured credit card to establish credit.
How to Make Your Choice
When choosing a secured credit card, it is essential to compare interest rates, annual fees, and credit limits. Some of these cards charge high annual fees, while others offer lower fees and more benefits. Be sure to know what you can afford so you don’t end up in debt management. Additionally, it is important to choose a secured credit card that reports to all three credit bureaus (Equifax, Experian, and TransUnion) to ensure that your credit history is being reported accurately. Reading reviews and researching different options can help you make an informed decision.
Using a Secured Credit Card to Build Credit
To use a secured credit card to build credit, it is important to use it responsibly. Make sure to make payments on time and in full every month to avoid late fees and interest charges. Additionally, it is recommended to keep your balance below 30% of your credit limit. This is because high credit utilization can negatively impact your credit score. The overall reason that high credit utilization hurts your credit score is because it indicates to lenders that you rely too heavily on credit, and you may not be able to pay off your debts. Plus, if you’re carrying high balances on your credit accounts, that leads to higher interest rates. Then it becomes even harder to pay on time and in full. Therefore, we can’t emphasize responsible credit card usage enough.
By using a secured credit card responsibly, you can establish a positive credit history and improve your credit score over time. Typically, a credit score of 670 or higher is considered good, while a score of 740 or higher is considered excellent.
Graduating to an Unsecured Credit Card
After consistently using a secured credit card and making payments on time, many card issuers offer an unsecured credit card after one year. Unsecured credit cards offer better rewards and lower interest rates, but they also come with higher credit limits and a higher risk of accumulating credit card debt. Therefore, it is important to continue using credit responsibly and only apply for an unsecured credit card when you are financially ready. Signs of being financially ready include an improved credit score, a debt-to-income (DTI) ratio of 36% or lower, and a higher income that shows you’re more financially stable to make payments on time.
Secured credit cards are a great option for individuals who are starting to establish their credit history or rebuilding their credit after struggling with consumer debt. By using them responsibly, individuals can establish a positive credit history and improve their credit score over time. When choosing a secured credit card, it is important to compare different options and choose one that meets your needs and financial situation.
If you’re struggling to pay off debt, ACCC can help. Schedule a free credit counseling session with us today.