Should you get a secured credit card to establish or rebuild your credit? It depends on your unique financial situation. Here's why.
Credit scores can literally make or break your personal bank. The higher your credit score, the more money you will save in the form of lower interest rates.
And as for those too-good-to-be-true financing offers advertised on television for big-ticket purchases, they are typically reserved for the “golden children” of credit. Those with less-than-perfect scores must settle for the shabby rates.
So, what if you’re new to the credit world or need help giving your three-digit number a boost? Assuming you are running low on options, a secured card is definitely worth considering.
What is a secured credit card?
For starters, a secured credit card is an alternative form of magic plastic that requires a cash deposit, which serves as collateral to establish a line of credit. It caters to newbies or those who are trying to rebuild their credit.
In most instances, your credit line will be determined by the amount you deposit, and most companies have a minimum that ranges from $200 to $500.
However, you may be granted an increase or promoted to an unsecured card after you have displayed responsible card use over an extended period of time. And your cash deposit will be refunded if the card is managed properly.
How secured credit cards rebuild credit
Similar to unsecured accounts, the best secured credit cards report account activity to each of the three major credit bureaus. Therefore, you should make timely payments each month, as 35 percent of your FICO score, the most commonly used credit score, is determined by this factor alone.
If the card issuer you are considering doesn’t report to the major credit bureaus, look elsewhere, because possessing that card will do the same thing that a debit or prepaid card does for your credit score: absolutely nothing.
In addition, try to keep the balance on the card low at all times. The amount reported to the credit bureaus is usually what appears on your monthly statement, even if you pay the outstanding amount in full before the due date.
How low? CreditCards.com says:
[FICO] had told people to keep it to 10 percent or less, says Anthony Sprauve, spokesman for myFico.com, FICO’s consumer website.
More recently, the company’s stance has softened, he says. Its studies indicate that there is only a minimal score difference between consumers who limit their usage to less than 20 percent and those who keep it to less than 10 percent, he says.
Should I get a secured credit card?
A secured credit card isn’t for everyone, but it is definitely an effective way to give your credit a boost if used responsibly. If you are a newbie to credit, a FICO score will be generated for you within six months of opening the account. On the other hand, if you are looking to start over, and have no other open cards in tow, the right secured credit card will do the trick.
However, if you already have outstanding debt balances on active accounts that are lingering, it may be wiser to allocate the deposit in that direction instead of opening a secured card just to lower your credit utilization ratio.
The reasoning? John Ulzheimer of Smart Credit says:
First off, when you apply for a secured credit card you’re actually applying for credit, which means the issuer is going to pull one of your three credit reports and make a credit card inquiry.
Second, if approved and reported to the credit bureaus, you’ve got a newly opened credit card dragging down the average age of your account history – neither of these is good for your credit scores.
Finally, you could have gotten the same value in the balance-to-credit limit ratio by simply taking the money you used as the security deposit and applying it to your credit card debt on an existing credit card. Taking this approach lowers your aggregate credit card balances, while not exposing you to the credit fallout of opening a new account.
And bear in mind that building your credit score takes time. If your credit is already shot, some things will just have to run their course.
Compare your options
As with any other debt instrument, you should read the fine print before signing up because all secured credit cards are not created equal. Bankrate says:
Howard Dvorkin, president of Consolidated Credit Counseling Services Inc. in Fort Lauderdale, Fla., a nonprofit organization that helps people get out of debt, calls secured credit cards “a Clint Eastwood movie — the good, the bad and the ugly. Some are good. They have low fees and treat customers as customers instead of as cattle. The bad ones take advantage and extort the clients because of their situations. Then there’s the ugly, which are completely despicable. They’ll give you the card, but you have to buy this insurance policy for $55 a month.”
Pay close attention to the disclosures regarding the APR, reporting practices and any other fees that may apply to avoid being caught off guard. Also, confirm that your deposit will be held in an interest-bearing account before signing up.
It’s typically easy as pie to obtain a secured credit card because you’re on the hook with your deposit. Check out our Credit Card Finder to locate a secured card that best suits your needs.