How Secured Credit Cards Work
When an individual applies for a secured credit card, he is required to make a good faith payment to the credit card company. The payment can range from $250 - $1000 or more. However much the individual provides as a good faith payment will determine his spending limit on the card.
Some credit card companies that offer secured credit cards will only require borrowers to provide a certain percentage of their spending limits. Thus if a borrower wanted a spending limit of $1000 and was required to provide 75% of his credit limit, he would make a one time payment of $750 to the credit card company before he could be approved as a cardholder.
Use a Secured Credit Card to Improve a Credit Score or Build a Debt Profile
A secured credit card must be used in much the same way as a secured credit card when attempting to build credit or improve a credit score.
- Make small purchases. Consumers should always make small purchases on their cards to ensure that the ratio of the amount they owe is always much lower than their balance. This is known as a debt to limit ratio. A high debt to limit ratio will increase a credit score while a low debt to limit ratio can cause scores to drop (See Calculate a Debt to Limit Ratio).
- Pay on time every month. Payment history is the single biggest factor that the Fair Isaac Corporation looks at when calculating FICO scores. One missed payment can cost an individual credit points.
- Make regular purchases. Not using a card will result in the credit card company eventually revoking the card.
- Monitor credit scores and apply for an unsecured credit card. Borrowers who opt for secured cards should keep an eye on their credit reports and apply for unsecured credit as soon as their scores climb high enough to be eligible (See Learn How to Read a Credit Report).
The Federal Trade Commission cautions potential borrowers to check with their credit card companies to ensure that the secured card will report to the credit bureaus. If the credit card company fails to report an individual’s payment history to the credit bureaus, the card will not appear on the individual’s credit report and will not help him build up his score.
Warnings About Secured Credit Cards
Because secured credit cards are extended to high risk borrowers, they often come with unpleasant conditions such as the following:
- Annual fees. Although some unsecured credit cards also charge annual fees, the majority of secured cards will. These annual fees are often much higher than those charged by unsecured cards.
- High interest rates. Due to the higher risk associated with extending credit to borrowers with a bad credit history or no credit history, secured credit card companies will often charge very high interest rates.
- Additional fees. Borrowers will often be required to pay a fee just to apply for the card. Other fees, such as processing fees, may also apply.
Liz Pulliam Weston of MSN Money recommends that borrowers talk to their banks about applying for a secured card. According to Weston, many banks will be willing to place a consumer on a “trial period” with a secured card for 12 to 18 months. After this time frame, the bank will then issue the individual an unsecured card.
Things to Consider When Building Credit With a Secured Card
Each credit card company’s policies will vary. It is imperative that borrowers research the different secured credit cards available to them before making a decision. Once an individual has settled on a card he wishes to apply for, reading and understanding the terms and conditions is a must. Once the credit card application is signed, there is no going back.
If a borrower understands his contract and uses the card properly, it can be a useful tool to build good credit that will be beneficial for years to come.