Secured credit cards are most frequently used to build credit, either after bankruptcy or when someone is new to the credit market altogether. Although secured credit cards do require a deposit, the deposit typically won’t exceed the total balance in credit you are granted. Thus, you are effectively building credit while using a credit card in the same way you would use any credit card. This presents a lower risk to lenders, especially when your credit history is poor.
How Do Secured Credit Cards Work?
When taking out a secured credit card, you still apply just as you would for any other credit card. Lenders will check your credit score and verify where it stands, usually according to FICO. A positive score of 700 or higher will result in a lower security deposit, if any, while scores of 600 or less may result in a heightened deposit. You must pay the deposit amount first to access your card. You then receive a credit card with a limit in the amount of your security deposit. Most companies will refund the deposit after one to two years of responsible use and graduate your account to an unsecured card - this is often called "graduating to an unsecured card".
Credit Limits on Secured Credit Cards
Typically, secured credit cards are granted to individuals who are still growing or expanding their credit. Because this group presents a heightened lending risk, you can expect to receive a credit limit that is lower than credit cards for prime lenders.
However, this just means that if you want a higher credit limit, you add more to your security deposit.
Starting limits typically fall between $300 and $500 for the most credit challenged individuals, but most secured card issuers allow you to deposit as much as $5,000. Just as with regular credit cards, using your card responsibly will gain you access better cards that do not require a security deposit and carry lower interest rates.
The main drawback of putting a large security deposit on a card is that you need to lock this money in the bank account for the time that you are using a card. Some banks will pay an interest on the security deposit, making it a bit sweeter for you to keep your money in the bank.
Some banks use a hybrid approach and offer a secured card with a credit limit that is higher than your security deposit. This is a great opportunity and, usually it is offered for people with better credit.
One example of such card is the Capital One Secured MasterCard - it can have a security deposit as low as $49 if your credit fits in the range. $49 minimum deposit will get you a $200 credit limit, and you can put up to $3000 in a deposit if you want a greater limit.
Why Low Deposit Might be a Bad Idea
The main purpose of the secured card is to earn a better credit history. One of the significant elements of the credit scoring model is the credit utilization - a percentage of the credit limit available to you that you are actually using from month to month.
Credit utilization makes up to 30% of your FICO credit score, so it is one of the major factors in your credit building plan.
A good credit building tactic is to use no more than 30% of your available credit limit. For example, if your total limit is $300, you should never make more than $100 in purchases on a card, and refill your balance several times a month if needed to keep this utilization low.
With a card with low security deposit, your credit limit will be low as well, so it will be harder for you to follow this essential 30% utilization rule. So it makes sense stretching your security deposit to earn credit faster and build a secure financial future.