There is no denying that credit cards have become a very crucial component of the modern way of life. You can use your credit card to pay for a product or a service online, or even make a payment at some brick and mortar stores.
However, if you have never had a credit card or have a very poor credit rating thus would not be able to apply for a credit card, then you need to find an alternative that would apply in your situation. As such, you may want to apply for something called secured credit cards.
Secured credit cards are those cards that need a cash deposit or collateral before you can use them to pay for your goods and services. This means that if you want $1000 worth of credit, you would need to deposit in $1000 up front. In order to get more credit, you would have to deposit more money as your collateral. At times however, your credit card company may reward you by increasing your credit limit, even if you do not deposit or request for it. This can happen if you have been faithful in servicing your bills on time.
So, how does a secured card work?
In order to secure the amount of credit you are seeking, you have to begin by placing funds in your secured account. Your credit company will then use this certificate of deposit or CD as a hedge to guarantee that you will repay the money you borrow. If you default in repaying the money you have borrowed, then your creditor will claim the funds deposited in your certificate of deposit to recover their money.
The Good news is that your certificate of deposit earns interest while you improve your FICO rating. Thus, if you set a line of credit with a secured credit card amounting to $2000.00, your $1000.00 will earn interest; and if you can develop the habit of paying your bills on time, then your credit line too will earn money for you! However, the drawback is that sometimes your credit card company may report that you are using a secured card and report this information to the credit bureaus. In doing this, they will make your account look a little less authentic since there is reduced risk to the credit card company. However, you can always shop around for a credit card company that will not report that you are using a secured card, and most creditors will honor your request should you ask.
What fee should you expect when using a secured credit card?
The most important thing that you need to look out for when applying for secured credit cards is the fee. Here are the common fees that you are likely to see:
- Card application fee. Nearly every secured credit card will come with an application fee of about $50 to $100. If you can find a company or bank that does not charge application fee, give them serious consideration because this is a worthwhile saving.
- Annual fee. Every secured credit card has an annual fee that can range from $30 to as much as $100.
- Expedite fee. If you are in a rush, some creditors will offer the option of paying an expedite fee to ensure that your card is processed faster.
Who is eligible for a secured credit card?
Most secured credit cards are available to everyone, including people with poor credit or no credit. Credit card companies are not as concerned about you defaulting in making payments since you have to make a deposit before asking for credit. Thus, if you fail to pay your bill, the creditor will simply claim the collateral you deposited to recover their money.
What are some of the benefits of using a secured credit card?
There are several benefits that come with using this facility, especially if you have a poor FICO rating. Here are some of them.
1. Establishing your credit.
If you have never applied for a credit card, secured cards are an excellent first step towards building your credit history. Applying for, and using this card appropriately is an indication that you are willing to take extra steps to establish your credit.
2. Re-establishing damaged credit.
If your credit has been tainted, like that of 40 million Americans, then your application for the traditional credit card might not be successful. However, you will probably be able to qualify for a secured card, unless you are bankrupt. Establishing a good reputation with your secured credit card can go along way in reinventing your credit score and improving your FICO rating.
3. Gaining a built-in debt protection.
To most people, excessive spending plays a major role in damaging their credit. However, a secured card can act as a cap to how far you can spend money, making it harder for you to indulge in toxic spending. You will have the peace of mind that your credit is secured with your own money. Thus, should your account become overdue, it will likely be closed and your collateral seized to pay for your bills. This will certainly help protect you from racking up more credit card debt while taming your wild spending habit.
4. Avoiding subprime or expensive credit cards.
These cards have the reputation of gouging and preying on people with poor or no credit. Subprime cards’ fees can easily total $200 to $300 during your first year of use, which is about the size of the credit lines that come with them. You can avoid falling for a subprime card and have almost all of your credit line go up as fees. The creditor is usually the only beneficiary from these cards!
5. Same privileges as regular credit cards
Your secured credit comes with most of the same privileges as the traditional unsecured card, as long as you have a strong credit limit. You can use your card to transact almost anything from paying for products to making hotel bookings as well as car reservations.
6. Safe money
It is much safe to move around with a credit card than hard cash. Better still, thanks to your secured credit card, you will have the money available for your emergency.
7. Consumer protection
Another great benefit of using secured credit cards is that they provide a level of security since you will be protected by the Fair Credit Reporting Act (FCRA).
Drawbacks of using secured credit cards
Secured credit cards do a have some drawbacks that you need to know. Here are some of these drawbacks.
1. Security deposit.
In order to own a secured credit card, you have to “pay to play.” These cards require a deposit in the amount equivalent to the credit limit you will be seeking; thus, if you do not have money, then you cannot afford to pay a deposit to build your credit… another Catch-22.
2. Higher fees in comparison to the traditional credit cards
Most secured credit cards come with hefty fees, often including card application fees, processing fees, and annual fees.
3. Higher interest rates.
Secured credit cards often come with higher interest rates than conventional credit cards. However, you can avoid the high interest rates by paying your bills in full, and on time, every month.
So what questions should you ask before applying for a secured credit card?
A secured credit card can be perfect alternative to a regular credit card; however, before you apply for one, there are some questions that you need to ask the credit card company about the card. Here are some of them.
1. What are the fees?
Like most traditional credit cards, secured credit cards do come with fees. Some of the most common fees include the application, processing, and annual fees. However, these fees vary from one creditor to the other. Therefore, be sure to read the fine print in the credit card terms and conditions to understand all the fees, both one time and recurring, before applying for this facility. Avoid cards with exuberant fees that eat up most of your security deposit.
2. How much will you pay in security deposit?
Secured credit cards are guaranteed by a collateral that is kept in a savings account and claimed only when you fail to make your payments on time. Most secured credit cards come with the minimum and maximum deposit limits. Find out these limits and whether your deposit will earn interest; and if so, how much interest.
3. In what circumstances will your deposit used?
Some creditors will only use your deposit in situations of severe default, such as five to six months past due. Others claim it for a single default payment. Knowing the circumstances that will cause your creditor to make a withdrawal from your collateral can help you be more disciplined, especially if you are concerned about getting your entire deposit back.
4. What are the eligibility requirements?
Your income and age might influence your eligibility to apply for some secured credit cards. Even when you are willing to put down a collateral for a credit limit, card companies still have requirements in place that you must meet. Most secured credit card lenders will require you to have a checking or savings account with their bank before applying for this facility.
5. What will your credit limit be?
Most often, your credit limit will not always be the exact amount as your collateral. It can be some percentage of your collateral, making your credit limit slightly less than the deposit. Therefore, be sure to find out what this limit is and whether it is the best deal in the market.
6. What is the annual percentage rate or APR?
The annual percentage rate is the interest rate that is applied to balances that you carry beyond the grace period. The higher your interest rate is, the higher your finance charge will be whenever you carry a balance.
7. Will timely payments be reported to credit bureaus?
If you want to use the secured credit card to help establish or repair a bad credit, then your payments should be reported to the major credit bureaus. Secured credit card companies that do not report to bureaus will not be of any help to your efforts. However, ensure that the card is not reported in a way that reveals it as being a secured card. This will prevent instances of bias from future creditors.
8. Can the card be converted to an unsecured credit card?
The best secured credit card should allow you to convert to an unsecured credit card after a period of consistent and timely payments. Unsecured cards often attract lower fees, or no fees at all, a lower interest rate, and much fewer restrictions.
What are the telltale signs of the best secured credit card?
1. Zero Application Fee
Most secured card issuing companies will often charge new applicants a fee to operate an account with them. This fee can range from $25-$50, and even more at times. However, some creditors will not charge this fee to applicants. All you need to do is research online for one of these companies. Therefore, if a no fee application is crucial to you then search around for a company that charges zero application fee.
2. Account limit amount
While most secured accounts come with limits in the range of $250-$500, some people may need a higher limit in order to make all the necessary transactions. To cater for such people, there are lending companies that will issue lines of credit up to $5000 or more. Never forget that with a secured account, you will need to have the money to back up the balance that you are requesting from the lender. Look out for a lender with a higher upper limit.
3. No prior score check-
Some creditors will first run a FICO score check on you before approving your application for this facility. However, there are many creditors out there that do not do this. Not having your present credit score involved is important if you are repairing your credit or trying to improve your FICO score because these inquires can lower your scores. Again, you can use the power of the World Wide Web to find those creditors who will not check your score prior to approving your application.
What are the common pitfalls with secured credit cards and how can you avoid them?
Secured credit cards can help you build or rebuild your credit. However, they can be very costly, especially when they are marketed by dishonest ‘creditors’. Therefore, you need to figure out how to identify and avoid common pitfalls when using a secured credit card.
1. The Fees
As already mentioned, secured credit cards usually attract higher fees. Usually, you will pay more in interest because you do not have a strong credit history. Once you have built an impressive credit history, creditors will know that you are good for the money, and thus you can successfully apply for loans that are more competitive. You may also have to pay high application, processing, and annual fees. At times, these fees may be as much as your credit limit, hence your secured credit card can become less useful than you initially anticipated.
Modestly priced secured credit cards are certainly worth it if you want to borrow in the future as they will help you in improving your FICO score.
However, if you can only find deals with high fees, then decide whether this venture is worth the benefit of building or rebuilding your credit. You may pay several hundred dollars now; however, you will save several thousand dollars when servicing your mortgage or insurance. On the other hand, you may opt to live without credit by using your debit card for transactions. While none of these options is attractive, be sure to review your options and decide what is best for your needs.
2. Credit Reporting
The primary reason for using a secured credit card is to build or rebuild your credit. After doing that, it is best to move on. However, some creditors may not report your activity to credit reporting companies.
The only way you can build your score effectively is to provide a history of responsible borrowing. Most lenders rely on the information provided by the three major credit bureaus, Experian, Equifax and TransUnion, when assessing you as a borrower. Therefore, you want to be sure that you are appearing where they are looking.
Before applying a secured credit card, especially for purposes of building your credit, be sure to ask if the creditor reports to those bureaus. After getting the card, verify that your account is being reported by getting and viewing the entries in your credit reports.
3. Outright Scams
Secured credit cards are a very fertile ground for scam artists. Fraudsters know that your options are limited if you are looking for this facility, so you are less likely to turn down offers – even if they appear fishy. The best way to avoid rip offs is to work with reputable creditors. Start by inquiring if your bank or credit union is offering this facility. If they do not, check with other reputable creditors in your city. Beware of big promises, ‘credit repair’ outfits, and creditors with very sketchy background information.
A secured credit card is often the best alternative if you have a bad credit and thus cannot qualify for the traditional credit card. These cards are accepted wherever other credit cards can be used, and they can certainly be useful during times of emergencies as well as for transactions that require the use of a card, such as when you are renting a car. However, you need to understand how this facility works, its merits and demerits, and whether it is right for you before getting one.