A secured credit card requires that you provide a cash deposit as security for the lender before you can use it.
What is a Secured Credit Card?
A secured credit card works like a standard credit card except that you must place a cash deposit, protecting the lender should you default.
You can obtain a secured credit card through various financial institutions, including banks and credit unions.
Many are also available through alternative lenders and boutique financial services firms, including those in the fintech space.
Once you provide the necessary deposit and secure approval from your lender, you’re free to charge purchases to your card up to your credit limit.
As with a regular credit card, you’re responsible for repaying the money you borrow in a timely fashion, along with any applicable interest and fees.
The primary purpose of a secured credit card is to enable individuals to repair or establish their credit score, which is a crucial metric lenders examine when deciding whether to approve a loan application.
Typically, lenders prefer to extend financing to those with a credit score of at least 650.
If your score falls below this threshold, you’ll likely struggle to get approved for most loans, at least at a favourable interest rate.
Secured credit cards can be an exceptional tool for cultivating a positive credit history and gaining valuable experience managing debt.
A strong credit score and history are essential variables that banks use as part of the lending decision process.
By using a secured card responsibly, visible improvements in your credit will appear over time.
Eventually, you can graduate to an unsecured credit card (which requires no deposit) and gain access to other loans products, like mortgages and auto loans.
Though a credit check is usually not a requirement to get approved for a secured credit card, you need to provide proof of income.
Secured Credit Card Deposits
As mentioned, the deposit associated with your secured credit card serves as security for the lender.
If you default on your debt, your lender can seize your deposit to cover their loss.
Since secured cards are issued primarily to borrowers with tarnished or zero credit scores, the lender assumes a higher level of risk by extending credit to them.
With a cash deposit acting as a safety net, the risk of default diminishes substantially, which allows them to issue secured cards to borrowers who’d ordinarily fail to qualify.
The amount you must put down as a deposit varies from lender to lender.
You can usually expect a minimum contribution between $200 – $500, though some lenders ask for as little as $50, like Neo Financial.
The maximum deposit can be as high as $10,000.
Usually, your deposit size determines your credit limit, so the more you put down, the more you can spend.
Your lender holds your deposit in an interest-bearing bank account while using the secured card. They’ll release the funds to you once you decide to close your account.
Secured Credit Cards and Your Credit Score
The most efficient and effective way to boost your credit standing is to borrow funds and make on-time payments over an extended period.
Luckily, this is what a secured credit card allows you to accomplish precisely.
Your card issuer reports each timely payment you make to TransUnion and Equifax, which are Canada’s credit bureaus.
These two firms compile your credit activity and feed it through complex evaluation models to determine your credit score.
Your payment history and the average age of credit accounts you maintain constitute about 35% and 15% of your total credit score, respectively, according to Equifax.
Thus, by diligently making timely payments over many months and years, you can better your credit score.
However, just as quickly as a secured card can enhance your credit, so too can it damage it.
Your card issuer reports missed payments to the credit bureaus the way they do with on-time payments.
Your credit score will be downgraded accordingly if you consistently miss payment deadlines or default on your debt altogether.
In addition, it’s crucial to keep your credit utilization at a reasonable level.
Your credit score can take a dip if you routinely carry a high balance on your card.
Benefits and Drawbacks of a Secured Credit Card
A secured credit card can yield tremendous benefits but can also have drawbacks, depending on your needs and circumstances.
Here’s what you should consider before acquiring one.
Due to the security deposit, lenders feel more at ease extending credit to you, even if you possess a low credit score.
Since your creditworthiness is a far-less critical factor when applying for a secured card, your chances of obtaining approval are high.
Great for Credit-Building
Your card issuer reports each on-time payment you make to credit bureaus, which inevitably results in a rise in your credit standing.
Unlike an installment loan, you have the flexibility to borrow through your card only as much as you can manage to repay, which decreases the chances of missed payment deadlines.
As with a regular credit card, you also have the choice of contributing only the minimum payment required each month, which counts as being made “on time.”
Your Security Deposit is Refundable
As long as you keep your account in good standing with your card issuer and never default, you get your deposit back.
Higher Interest Rates and Fees
It’s not uncommon for secured credit cards to charge higher interest rates and fees than standard, unsecured cards.
The rate charged for purchases can be as high as 25% and cash advances as high as 27%.
Some cards charge annual fees, which generally range from $30 to $70; others may levy an additional monthly maintenance fee or setup fee when you open your account.
Deposit is Required
Unlike a traditional credit card, you must pledge a cash deposit before your lender will permit you to use a secured card.
It may not be economically feasible to allocate funds necessary to open an account depending on your present circumstances.
If you’re falling behind on your rent or utility bills, coming up with extra cash for a deposit could be challenging.
While some lenders allow you to contribute a small deposit, your deposit typically dictates the size of your credit limit.
Offers Fewer Perks
Credit cards are exceedingly popular for the perks they offer, especially when it comes to rewards programs.
Unfortunately, secured credit cards typically fall short in this category.
Since they’re geared toward those seeking to improve or build their credit rather than collect travel points to redeem on a first-class overseas vacation, they tend to skimp on perks.
Did You Know?
The Neo Financial Secured Mastercard comes with a rewards program that nets you 5% cash back on eligible purchases you make.
Frequently Asked Questions
- Do secured credit cards help build credit?
Secured credit cards are a great way to build up or fix your credit standing. Credit-building is, in fact, the primary objective of a secured card, which is why almost anyone can obtain approval from an issuer to use one.
Your card issuer reports your payments to credit bureaus, allowing you to improve your credit score gradually over time.
Most borrowers utilize a secured credit card for a brief period, mainly to elevate their credit score to where they qualify for an unsecured card or another form of financing.
- What is the best way to use a secured credit card to build credit?
Always pay your balance owing on time and only use 35% of your available credit limit, do not max out your card.