What Is a Secured Credit Card and How Does It Work?

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Secured credit cards are simply credit cards that require cardholders to make a cash deposit when they open an account. The deposit enables credit card issuers to provide cards to individuals with poor credit who would be ineligible otherwise. The amount of the deposit is typically the credit limit, meaning that there is always collateral for anything the cardholder spends. 

How Does a Secured Credit Card Work?

On first thought, a secured credit card might seem a bit backward. If the borrower has already sent the credit card company money, that doesn’t really sound like credit, does it? Well, that’s simply the nature of the contract to which the cardholder and issuer agree in the case of a secured credit card.

While regular credit cards can count on a cardholder’s income or assets to guarantee payments, secured credit cards rely instead on a cash deposit. The credit card company is still issuing credit, and the cash provided to them acts as collateral just as any other asset would.

Why Do People Get Secured Credit Cards?

The requirement for a cash deposit makes secured credit cards a less enticing option than regular unsecured credit cards. Many cardholders choose secured credit cards not because they prefer them but because secured credit cards are all that they can qualify for.

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For example, if an individual doesn’t have the necessary credit score or meet income requirements to get a regular credit card, they may choose to apply for a secured credit card.

Because there is explicit collateral, it doesn’t matter to credit card companies if borrowers have bad credit. They can have all kinds of credit problems and still access secured credit cards. Many people do so to try to start building or repairing their credit.

Improving Credit Scores With Secured Credit Cards

A secured credit card appears on a credit report like any other credit card. When payments are consistently made on time, a person’s credit score can improve. This can help people start to dig their way out of a bad credit history or establish a good credit score from the start.

Other options, like prepaid cards, do not report activity to the credit bureaus. Reporting is significant. People who choose secured credit cards need the credit bureaus to find out about their good behavior so that their credit scores can improve.

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Ideally, someone will eventually be able to use their secured credit card to build credit to the point that they can obtain a regular credit card.

Avoiding Potential Collection Issues

Having a credit card sent to collections can be a massive headache. It can severely impact a borrower’s credit score for years to come, potentially locking them out of auto loans, mortgages and more. One way to avoid this issue for good is to choose secured credit cards.

The issuing company can use a person’s cash deposit to pay for any delinquency. Instead of sending the account to a collection agency, they simply keep the cash deposit. While the cash deposit would be applied to settle the balance, the cardholder could accrue additional fees that wouldn’t be covered. The card issuer will cancel the card to prevent further charges, but this does not prevent interest or fees from causing the balance to exceed the cash deposit.

It also means that they won’t be dealing with debt collectors. Collection agencies can be aggressive and even veer into harassment. There are consumer protections in place that are meant to control this behavior, but even legal collection measures can be a major disruption.

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Reliable Access to More Payment Options

There are plenty of payment options in the modern world, from digital wallets to cryptocurrencies and more. However, few can contend with the universal acceptance that credit cards enjoy. Credit cards work just about everywhere. They’re accepted in person, online and even over the phone.

If a person has bad credit, an additional benefit of secured credit cards is having easier access to a variety of goods and services. With a credit card, they can much more easily sign up for paid apps, shop online or even simply use the credit card to track certain spending. There are other ways to do all of these things, but none of them are as consistent and reliable as a credit card.

Secured Credit Card Rewards

While most secured credit cards have fairly bare-bones offerings, many feature the same types of rewards that other cards offer. These could be in the form of rewards points, cash back on certain purchases, travel miles and more. Secured credit card owners likely won’t get the best rewards out there, but with certain cards, they’ll be able to get something.

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Keeping Credit Management Simple

For individuals who tend to let their credit run away from them, a secured credit card can be an effective, if inelegant, solution. Without the ability to overspend beyond their credit limits, borrowers aren’t able to build up excessive credit card debt.

A Clear Path to Better Credit Options

Depending on the specific type of secured card chosen, borrowers may have access to a set timeline until they can receive a regular credit card. Many credit card companies will offer a specific period of time over which borrowers can show their ability to make timely payments. At that point, they can then upgrade to one of the company’s standard credit cards.

What Are the Downsides of Getting a Secured Credit Card?

Of course, there are some downsides to having a secured credit card. The fact that people typically only resort to them as a final option shows that most consumers would rather avoid them when possible. While a secured credit card has many upsides as well, there are certainly reasons to avoid them.

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Securing the Deposit

Unfortunately, the people who need secured credit cards the most are the most likely to be unable to gather the necessary deposit. Most secured credit cards will have an absolute minimum of $200 for a deposit, with the option to go up to $2,500 or higher. For an individual or family struggling with debt and other financial issues, getting this money together for a secured credit card deposit can be a significant challenge.

Not Always Available

While secured credit cards market themselves as an option for everyone, that isn’t always the case. Individuals can still find themselves rejected when applying for secured cards.

Major events like non-discharged bankruptcies could be seen as too risky even for secured credit cards. While there are cards out there that don’t require these credit checks, they can have extremely high fees and interest rates.

Paying Interest

Even though the credit card company has the borrower’s money, they still accrue interest on any unpaid charges from month to month. In fact, many secured cards have higher interest rates than regular credit cards. They certainly have worse rates than premium cards that offer significant discounts.

While people with secured cards can still take advantage of grace periods and avoid any interest by paying the balance off in time, this can pose a challenge for individuals who have already had credit issues in the past. Most people who manage their credit closely won’t need to apply for a secured card in the first place.

Getting a Secured Credit Card

Secured credit cards are offered by most major banks in the U.S., along with all of the major credit card providers. Visa, Mastercard, Capital One and Discover are just a few examples of credit card issuers that offer secured cards.

When applying for a secured credit card, borrowers can still expect a hard credit check. The credit card company will use the borrower’s credit score to determine the amount of secured credit for which the borrower will be eligible.

Moving Up From a Secured Credit Card

With some secured cards, if everything goes as planned, the cardholder will eventually be able to make the change to a regular credit card. Many credit card issuers have their own guidelines for when their customers can make the transition. Even if this isn’t the case, the gradual improvement in credit score can allow the cardholder to apply successfully.

Good To Know

If the card issuer doesn’t allow upgrades or the borrower wants a regular card elsewhere, they can simply close their secured credit card. If there isn’t an outstanding balance, they’ll receive their original deposit back when they do so.

Final Take

A secured credit card is a straightforward way for individuals to restore or start building their credit. It does not offer the same range of benefits that borrowers can get with a regular credit card, but it’s a safe and effective intermediate step on the way to better credit options.