If you have a thin credit file or a poor credit history, a secured credit card can be an excellent way to beef up your credit score.
Unlike a credit card, where lenders give you money to use and then ask you to pay it back each month, a secured card works the opposite way. With a secured card, you have to put down a deposit with your own money. When you give the bank your deposit, they’ll issue you a line of credit that will most likely be equal to the amount you deposited. Sometimes, however, your secured card limit may be a bit higher than your deposit. Think of that deposit as collateral. If you stop making payments on your card, the bank will simply keep your deposit.
But the key is that every time you make a payment on the card, the bank will report it on your credit reports. And over time, your credit score will improve.
Your goal with the secured card is to demonstrate how responsible you can be. This will in turn improve your credit score. You should focus on (1) keeping your credit utilization low and (2) making full, on-time payments each month. Those two factors alone make up 60 percent of your credit score.
- Use the secured card. If you don’t use the card, it won’t improve your score by much. Charge a small amount to the card each month and pay it off in full. Aim to carry a balance that is no more than 20 percent of your available credit limit. That keeps your utilization low and will in turn help your score.
- Pay your balance in full each month. You can make sure you do this by signing up for automatic monthly payments. This also helps you avoid accruing interest by carrying a balance each month.
- Sign up for a credit monitoring service such as Credit Karma, Discover’s credit scorecard, or another service that lets you check your report monthly, for free. You can also get a free annual credit report from all three bureaus at AnnualCreditReport.com.
- Check your credit report monthly to make sure the bank is reporting your secured card behavior to the credit bureaus. If the bank doesn’t report your behavior to the bureaus, you’re missing out on the main benefit of having a secured card.
No matter what your reason for using a secured card, you should understand that the credit-building process will be slow. It may take a year or longer to lift your score by 100 points.
The secured card you choose will ultimately depend on a personal assessment of your fiscal habits and a careful review of the card’s terms. Your best bet will be to look for a card with no annual fee, a low minimum deposit, and the lowest annual percentage rate (APR).
Here are key factors to consider before you choose a secured card:
The interest rate. Choose the card with the lowest rate possible. Secured cards usually have higher interest rates than regular credit cards. For example, you’d pay about 23.24% APR on the Discover it Secured Card and 22.24% on the Citi Secured MasterCard compared to 15% on average for regular credit cards.
The deposit amount. Find out how much you have to put down to get the limit that you want. Sometimes the deposit is only a fraction of the card’s credit limit. If you get a card with a limit that is higher than your deposit, have a heart-to-heart with yourself to be certain that you can manage the limit responsibly.
You’d also want to know how long the bank will keep your deposit after you close the secured card as it might not give it back to you right away. Some banks will keep the deposit to cover any charges to the card for a couple of months after you close the account.
Fees and charges. Like credit cards, secured cards can also come loaded with hidden fees and other charges. These can eat away at your security deposit and your card limit if you’re not careful. The Consumer Financial Protection Bureau has a great example of a credit card agreement that highlights what you should look out for. A couple of the most important items to check are if the card has an annual fee and if it has a period after which the interest rate you’re paying will increase.
Perks. Most secured credit cards don’t offer any rewards, but a few, like the Discover it secured card, let you earn rewards for your purchases. The Discover it card also gives you cash back on certain purchases. You shouldn’t focus solely on the perks when choosing a card, but they are nice to have.
MagnifyMoney is a price comparison and financial education website, founded by former bankers who use their knowledge of how the system works to help you save money.