February 2, 2019

How to Build Credit with Secured Cards

If you are someone with a low credit score or no credit whatsoever, finding the right path forward can be difficult.

  1. You know you’ll need a credit score to get a home loan in the future (from 90% of lenders).
  2. To get a credit score, you’ll need to start building a credit history, typically by using a credit card responsibly.
  3. To qualify for nearly all credit cards, you have to have…you guessed it…a credit score.

Do you see the circular reasoning? Frustrating isn’t it? I know it definitely frustrated my wife and me when we were in the midst of trying to buy our first home.

So what are young adults to do to begin building creditworthiness? Are student cards the best option? I would say no. The CARD Act of 2009 made it a requirement for students under age 21 to have a co-signer when they sign up for a student credit card. Co-signing is a bad deal for the co-signer, so, for your parents’ sake, I would discourage you from choosing this route.

Getting yourself added as an authorized user to your parents’ card would slowly build some credit for you, but it’s still not my favorite choice. In my opinion, the most direct route you can take to building your own credit is to sign up for a secured card. Check your credit score for free with Credit Karma.

What Is A Secured Credit Card?

With a secured credit card, the cardholder is required to make a cash deposit of usually around $200-$300. This money is held in a separate account and acts as “security” for the bank in the event that the cardholder does not make their payments on their card. The cardholder’s credit limit equals whatever deposit was made. In this way, the banks limit their risk.

The benefit to you is that your on-time payments are reported to the credit bureaus just like with an unsecured credit card, which allows you to begin building a credit history and credit score. Typically, banks encourage secured cardholders to make one or two small purchases, like a gas tank fill-up, each month and then pay each statement balance off in full.

Eventually, once enough on-time payments have been made, your bank will graduate your card up to an unsecured status and your deposit will be refunded to your account. It takes between 6-18 on-time payments for most banks to graduate their secured card users to unsecured cards. Most will graduate their users on or before their 12th payment.

Do Secured Cards Report as Regular Credit?

Yes and no. This is an area of confusion for many people. Most secured cards do have a coding designation that would allow someone who was checking your credit report to know that they were, in fact, secured cards. But, unlike what many think and teach, this does NOT affect how the FICO scoring model views the credit.

As far as your FICO score goes, credit history from secure cards is weighted just as high as from unsecured cards. There are other reasons why secured cards are not as efficient at building your credit as unsecured cards (which we will explain below), but the way secured cards are reported to the credit bureaus is not one of them.

What Are the Downsides?

1. Up-Front Cost

While secured card cards can offer a great path to building credit, there are negatives that you need to be aware of. The first downside to secured cards is the most obvious – you’re going to have to put up the money for whatever deposit is required.

It’s important to note that secured cards do not work like prepaid cards. You cannot use the money from your deposit to pay off your balances. That money is only available to be used by the bank if a cardholder defaults on their debt. You will not see that money again until you graduate to an unsecured card. This is one of the reasons why it’s so important to shop for a secured card where the bank is known for graduating its users as soon as possible.

2. Higher Interest Rates

The second downside is that secured cards usually have higher interest rates than secured cards. The banks know that they are taking on a higher risk by giving a card to someone with no credit history or a low credit score, so they charge higher rates as compensation for that risk.

And, once again, secured cards are NOT like pre-paid cards. In other words, even if your credit limit is very low, your actual balance on the card, with interest included, can rise exponentially above that limit if you do not pay off your statement balance each month.

3. Lower Credit Lines

The third downside is that since secured cards typically have lower credit lines it makes it harder to keep a good credit utilization rate, which is one of the most important factors that affect your credit score. Your credit utilization rate is simply how much of your available credit you are using each month.

Most experts say that in order to get the best credit scores, you want to keep your utilization rates below 30%. In other words, if you have a $10,000 credit limit, you never want to spend more than $3,000 in a given month. That may not seem like too difficult of a task, but imagine how the situation changes with a credit limit of $300. Then, the most you could spend in a given month to stay in the 30% utilization range would be $90.

Where Can I Get a Secured Card?

I usually recommend that individuals who are wanting to get a secured card start by checking with their bank. That way they can have all of their accounts in one place, and can quickly move money over each month to pay off their statement balance. It makes for less confusion and complexity as you’re getting used to the whole process of paying credit card bills.

However, if your bank charges high fees for their secured cards, then I recommend checking out Nerdwallet’s list of the best secured cards of 2018.  As you are thinking about which card to apply for, just remember that you want to find a card with low fees and a reputation for graduating its users to the corresponding unsecured card on a timely basis.

And as your working to improve your score, remember that you can always check your credit score for free with Credit Karma.

About the author 

Clint Proctor

Hi, I'm Clint! I love writing about everything personal finance. In addition to this site, my work has been featured on several major publications including Business Insider, Forbes, Credit Karma, and U.S. News and World Report. My hope is that you'll be able to find plenty of helpful information and inspiration on this site to help you reach your financial goals. Thanks for visiting!

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