If you live in the United States, creating credit and having a good credit rating are essential for most of life’s major purchases, like buying a car or a house. But it’s hard to get approval for products that create credit if you don’t have one to begin with. This is where tools like secured credit cards come in handy.
A secured credit card works by allowing you to put down a deposit to act as collateral with the lending agency, making it a much safer option than a typical credit card for you and the lender. Because of this cash deposit, you are more likely to be approved by the credit card company and be able to start repairing or strengthening your credit. As long as your account remains in good standing, the card issuer will usually refund the deposit after a certain number of months or when you close the account.
But just because secured credit cards are a great way to accumulate credit without the risks of a typical unsecured credit card, doesn’t mean they’re a silver bullet – you need to do it right. way if you want to use one to repair or increase your credit score. Here’s how to get a secure credit card and use it to build credit:
Why is your credit score important?
A credit score is a three-digit number assigned to consumers based on information gathered from the credit reporting agencies that determine your creditworthiness. It helps lenders decide how much money to give to you and on what terms / rates, depending on your risk as a borrower. The factors that make up your overall score include your credit history (how long you have had loan accounts), your credit utilization rate (the ratio of how much credit you actually use to how much you have. ) and your payment history.
Any loan products you have in your name, such as credit cards, mortgages, auto loans, and student loans, will be included in the credit report, which will then determine your credit score. So if you default on a loan or have a large balance on your credit card, it will impact your credit rating * and potentially prevent you from accessing loans or even renting a home.
This can be even more difficult for those with little or no credit history: According to a 2015 report from the Consumer Financial Protection Bureau, about one in 10 Americans is considered âcredit invisible,â which means they don’t have enough credit history to even generate a score. Without a credit score, you probably won’t be able to access any loan products, which is why secured credit cards are a particularly good place to start (or restart).
How Can a Secured Credit Card Help You Build Your Credit?
Besides the initial deposit, secure credit cards help you build credit just like any other credit card: by making purchases with the card, then paying them off on time each month.
You should only spend less than you can afford to repay, so if your secured credit card has a monthly limit of $ 500, your goal would be to spend less than $ 150 each month. You also want to be sure that you never spend more than what you can afford to pay back, even if that means spending well below the recommended usage rate of 30%. Making payments on time each month and keeping your usage rate low will help improve your credit score over time.
Many people even set up just one or two strategic recurring payments on their secure card each month and nothing else, so they’re never surprised or looking for money when the bill is due. For example, you can charge just your monthly $ 60 internet bill to the card, pay it off while still achieving a decent credit score over the course of a year or two.
Can a secured credit card further damage your credit score?
A secured credit card is not a Get Out of Jail Free card: the security deposit simply protects you from being sent to collections if you stop making payments, unless your overdue balance is greater than the deposit. himself. Missing or late payments will always negatively affect your credit score, rendering the benefits of a secure credit card unnecessary.
Secured credit cards also don’t tend to offer very competitive interest rates, which means they’re usually much higher than a regular card. If you don’t pay off your card balance in full each month and allow interest to accumulate, you could end up with a much higher balance than the original, which again hurts your score.
Additionally, the minimum security deposits for secured credit cards are usually around $ 200 or $ 300 (although cheaper options can be found) and you must provide it as soon as you are approved. Otherwise, the lender will not issue the card, and since the application process will likely have dropped your credit score by a few points through a thorough credit check, you will end up with a lower credit score than you did. you had initially.
If you don’t have the money for the security deposit, you will need to save up before you apply to avoid this situation. Or, if you already have other outstanding balances that could benefit from an additional $ 300 payment, it may be better to correct your credit rating by paying off that debt rather than taking out another line of credit.
How to choose the right secure credit card for you
In addition to the security deposit, some secured credit cards come with an annual fee of up to $ 50 per year, as well as potential application and processing fees. You can avoid paying many of these fees as long as you find a card that offers the right balance of benefits and affordability. At a minimum, you should be able to comfortably cover the cost of the security deposit, fees, and monthly payments if the secured card is to help you develop your credit.
Another important thing to note: Some secured credit cards marketed to people with bad credit do not actually report to any of the three credit bureaus. This means that if you use one of these cards, none of your activities will count towards your credit score, which will render the card unusable if your goal is to use it to create credit. To avoid this, be sure to do your due diligence by reading the fine print on each card when shopping. Contact the lender if it still isn’t clear.
Switch to an unsecured or “regular” credit card
Some secure credit card lenders will allow you to convert the account to an unsecured card (that is, a card that does not require a down payment) once your credit score is considered “fair” or ” way “. In other cases, you may need to apply for an unsecured card yourself and close the secure account.
Either way, it’s important that you are prepared for success before you make the switch. While they may come with more benefits and fewer limitations, using an unsecured credit card can put you at risk of going back to where you started by damaging your credit score. If you don’t trust yourself not to spend too much money or worry that you don’t have enough money to make payments on time, you better stick with the secure card.
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