Advantages and Drawbacks of Secured Credit Cards

Credit cards are powerful tools that can help you when you’re in a pinch. But, they are also financial instruments that can also lead to a continuous cycle of debt if you’re not careful.

At the same time, many people have been unable to qualify for a credit card at a decent interest rate in the wake of the Great Recession. One possible solution for both of these problems is a specific type of credit card called a secured credit card.

Secured credit cards help you rebuild your credit, but they can also help reinforce good borrowing habits and help you get out of the cycle of running up credit card debt.

What Is a Secured Credit Card

A secured credit card works much like a normal card, but with vastly different qualifications and practices. Cardholders must first submit a deposit before obtaining a secured credit card. In most cases, the amount of the deposit becomes the cardholder’s line of credit.

For example, if you deposit $500 into your account with a secured credit card, you can charge up to $500, and the bank replenishes your borrowing limit as you pay back the debt. But, other secured credit cards may offer an even higher credit limit than the initial deposit you send the credit card company.

The good news is that most applicants are granted secured credit cards regardless of their credit history because collateral, like a home mortgage or a car loan backs the amount you borrow. It’s essentially your own money since you made an initial deposit that became your credit limit. The exception is for people who cannot prove their identity and those who have a bankruptcy pending.

Secured cardholders can then use their cards much like a standard credit card. You receive monthly statements and must make minimum payments on time or face penalties. Just like regular credit cards, companies that issue secured credit cards report both your positive and negative actions to the credit bureaus. So, if you’re on time with your credit card payments, you should see your credit score rise. But, if you continue to miss payments like before, your credit score will take a hit even with a secured credit card.

Secured credit cards function almost exactly like regular ones. Cardholders will incur interest on any revolving balance, regardless of the amount of your initial security deposit. Fortunately, the deposit on some secured credit cards actually accrues interest on behalf of the cardholder. For example, the USAA secured credit card converts the initial deposit into a 2-year certificate of deposit (CD) which earns interest for the cardholder.

The Benefits of a Secured Credit Card

Federal law covers secured credit cards to protect users just like it does for standard credit cards. There is a limit to cardholder’s liability in the event of theft or fraud, and cardholders can request a chargeback in the event that you paid for goods or services and then didn’t receive them.

As I mentioned before, secured credit cards are also an excellent way to build (or rebuild) credit. Most issuers will report timely payments to the major credit bureaus. So, a secured credit card can be a great choice for someone just starting out that doesn’t have a credit history. These cards can help you build one. And, they can also help you rebuild a poor credit score as well.

After you make timely payments for a year or more with a secured credit card, you may find it easier to successfully apply for a standard credit card than before. Finally, many secured credit cards offer rental car insurance as a benefit just like traditional ones.

The Disadvantages of Secured Credit Cards

There are a few drawbacks to secured credit cards that you need to be aware of though. Many banks load secured cards with fees. Customers should avoid cards that charge monthly fees. Even if the card has a low $9 per month fee, it can add up to almost $100 per year. In contrast, major banks such as First Progress offer a secured credit card for only $29 a year.

Another disadvantage is that these cards typically have a very low credit limit. So, they may not be ideal if you’re looking to make larger purchases in the near future.

Cardholders should also look out for additional cost programs that banks heavily promote. For example, many secured card issuers offer “payment protection” and other quasi-insurance programs for a large monthly fee. While these programs may seem like a good deal on the surface, they typically only pad the pockets of the banks that offer them.

Like most specialized insurance, they’re hardly ever needed or claimed, and the banks are betting on just that. That’s why they offer them. They wouldn’t offer these insurance programs if it didn’t make them a lot of money.

Also, cardholders can still accumulate fees and interest charges if they are unable to pay their balance in full and on time each month. The fees and interest are important considerations for those who have had trouble managing their finances in the past.c

Finally, these cards typically feature few benefits such as travel insurance and purchase protection that are common to most standard cards. It’s important to read the agreement and fine print for your secured credit card before you apply. You need to know what the fees are and the protections the banks include with the cards.

Secured credit cards can be a great tool. They can help you build a credit history if you don’t already have one. And, they can help you rebuild your credit after you run into trouble.

By understanding the advantages and drawbacks of this unique type of credit card, consumers can choose the right product for their individual needs.