What Is a Secured Credit Card and How Does It Work?

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Secured credit cards are an option to build or restore credit history.
Image Credit: Clark.com

If you are looking for a first credit card or have a less-than-ideal credit history and are having trouble getting one, a secured credit card may be the perfect solution.

Secured credit cards are a good option for building credit or credit score repair because they allow you to make a security deposit in exchange for a credit that will be reported to the credit bureaus.

“For someone who has never had credit or has a history of bad credit, a secured card can be a bridge to you establishing real credit. [They work] as long as you can maintain paying as you should,” money expert Clark Howard says.

I sat down with Clark to get some more insight on secured credit cards. We settled on four areas of concern that credit seekers should consider closely before deciding on a card. He also delivered some valuable information on why a credit union may be your best option for this type of credit.

Table of Contents

What Is a Secured Credit Card?

A secured credit card is designed to provide access to credit for first-time credit card applicants with no credit history or those who have a poor credit history and are looking to repair it. It is a real credit card that typically is reported to all three credit bureaus, unlike a debit card or a prepaid credit card.

In this scenario, “secured” means that the consumer is required to make a deposit to the lender in exchange for access to the card. This type of credit card is for consumers who do not qualify for a traditional credit card, whether it be due to poor credit score or lack of credit history. Once acquired, the card functions the same as a traditional credit card for transactions.

Many of the credit issuers that offer secured credit cards provide a path to issuance of traditional credit cards if the consumer establishes good credit behavior through habits like on-time payments, paying more than the minimum amount due, and low utilization of credit limit.

How Do Secured Credit Cards Work?

Each card provider handles the issuance of secured credit cards a little bit differently, but there are some commonalities in the marketplace.

At the core of each of them, the goal is for you to prove your credit-worthiness by offering up a deposit, making on-time payments and staying comfortably within your established credit limit.

Here are the main things to understand about how a secured credit card works:

  • Since you’re trying to build trust, you are going to be required to make a deposit (usually refundable) in order to gain access to a secured credit card. The dollar amount of the credit line offered may coincide with the deposit amount, meaning that you — at least in part — are borrowing against your own money in an effort to establish your long-term credit worthiness.
  • Your credit limit may be smaller on a secured card than with a traditional card. This is to protect the lender and yourself during the credit-building process.
  • Even though you’re making a deposit, you may still be subject to a credit check to receive a secured credit card. However, if you are, the standards issuers use for approval are generally lower than that of a traditional credit card.
  • You’ll be able to spend with a secured credit card the same way that you would with any other credit card, provided you’re within the credit limit. Likewise, you’ll be expected to make regular payments on monthly bills that are subject to late fees — just like a regular credit card.

Think of it this way: A secured card is almost like a training program for use of a regular credit card. There are safeguards in place to keep things on track in what is supposed to be a temporary arrangement.

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4 Things to Check Before Applying for a Secured Credit Card

Not all secured credit cards are created equal. During your search for the right secured card for your wallet, you’ll want to ask some important questions.

Clark says there are four things you’ll want to assess for potential red flags:

1. Are There Annual Fees Attached to the Card?

Several major credit card issuers, including Capital One and Discover, have secured cards on the market that carry no annual fee.

Remember that your goal should be to use this secured card as a bridge to gaining traditional credit. Because of that, you’ll want to get in and out of this arrangement forking over as little money as possible. By the time a year is over, you’ll hopefully be on the path to bigger and better credit options.

2. Is There a Clear Path to a Traditional Credit Card?

Clark believes this is an important question to answer as part of the secured card process. Again, it should be a temporary arrangement. Make sure there is a clearly defined path to getting away from using the secured card.

For example, Discover offers its secured card customers the promise of: “Automatic monthly reviews starting at 8 months to see if we can transition you to an account with no security deposit.”

If a secured card issuer has a long-term credit relationship in mind, it should have a plan for getting you into a more traditional line of credit. Clark recommends checking local credit unions for this type of relationship. More on that in a bit.

3. Are There Exorbitant Fees in Addition to the Security Deposit or Annual Fee?

Clark likes to refer to these as “junk fees.” And with a nickname like that, you probably already know that it is best to avoid them.

They can come in the way of escalating annual fees on existing members or an upcharge for access to a higher credit limit, for example. These fees aren’t always advertised prominently upon signing up for the card, so taking an extra few minutes to read the fine print on your agreement prior to signing off on it could pay off in the long run.

Don’t be afraid to ask questions about fees that make you uncomfortable. Remember, you’re the credit issuer’s customer!

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4. Is There a Sufficient Grace Period for Interest on Your Charges?

The answer to this one could have a direct impact on your pocketbook, so pay close attention. Most traditional cards will give you a grace period within a billing cycle during which you can accrue charges and pay them off before interest is due on the balance.

But some less-than-reputable secured card issuers will try to take advantage of unknowing credit seekers by charging a high rate of interest on your purchases shortly after they are made.

“They may offer you no grace period on your charges,” Clark Howard warned. “So you’re paying a very high rate of interest, even if you’re paying your balance in full every month.”

Make sure your new secured card offers a sufficient grace period so that you can pay the balance each month without owing extra money for interest.

Why Clark Howard Suggests Credit Unions for Secured Credit Cards

If you are ready to begin your hunt for a secured card, Clark Howard suggests that you start by checking out the options at your local credit union.

Many credit unions have programs in place for people who are looking to build or repair credit. And since credit unions are member-owned, they have a vested interest in helping you be the best credit customer possible.

Credit unions sometimes refer to these as “fresh start” programs.

Clark likes these because often the credit union will report your card activity to the credit bureaus as though it is a traditional card and not a secured card.

“They do this because you have to have a relationship as a member of the credit union and you have to have money on deposit with the credit union. They either strictly or loosely base your initial credit limit on the amount of money you have in the credit union. A lot of the secured cards from credit unions have no fees or very minimal annual fees.”

So, to recap, the reasons Clark likes credit unions for secured cards:

  •  They often have credit-building programs you can join
  •  Cards usually come without annual fees
  •  Some credit unions report your usage to credit bureaus as though it’s a traditional credit card
  •  There often is a clear path to a traditional credit card after good payment behavior

If you don’t have a local credit union to consult, you may want to check out some of the national options like Navy Federal Credit Union, which offers a secured card with no annual fee.

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Final Thoughts on Secured Credit Cards

Still trying to decide whether or not you should apply for a secured credit card? Here are some pros and cons to think over:

Secured Credit Cards: Pros and Cons

Pros Cons
Establishes credit history for new credit seekers Most require a deposit upon signup
Help rebuild credit for those in need of credit repair Some may not have a direct path to traditional credit card
Can be pathway to traditional credit card Some require an annual fee or additional fees

Bottom Line: If you are in need of a way to establish your ability to manage credit, signing up for a secured credit card is an option. But it should be considered a bridge to traditional lines of credit and is best suited for people who do not have a credit history or are in need of repair to their credit history.

Do you have experience with secured credit cards? We’d love to hear your thoughts in the comments below!

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