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How do secured credit cards work? What you need to know

Secured credit cards.

If you’re trying to build or rebuild your credit history, a secured credit card can provide some security — as long as you use the card responsibly.

Secured credit cards are the most basic type of credit card available. With this kind of account, you make a cash deposit to “secure” the card. This differs from a traditional (unsecured) credit card, which requires no cash deposit.

Because of that difference, it’s much easier to get approved for a secured credit card than it is an unsecured credit card.

Here’s how secured credit cards work:

‘Training wheels’ for credit

With an unsecured card, the card issuer is essentially betting that you’ll pay your bills on time and otherwise demonstrate you’re a trustworthy borrower. With a secured card, however, the card issuer is taking much less of a gamble on you because it’s holding onto some of your money.

“This credit card on training wheels allows you to prove your creditworthiness with no risk to the lender,” says personal finance expert Laura Adams, host of the “Money Girl” podcast.

Many big banks offer secured credit cards, including Bank of America, Capital One, Chase, Citibank, Discover and Wells Fargo. A number of credit unions have them as well.

Credit limits for secured cards

Consumer credit expert Beverly Harzog says the credit limit for a secured credit card usually equals the amount of the deposit; a $200 deposit, for instance, would result in a $200 credit limit.

But in some cases, a credit card company might issue a “partially” secured card. Under this scenario, a $49 deposit might lead to a $200 credit limit, Harzog says.

“A secured credit card looks like any other credit card,” she says, “so there’s no stigma attached.”

Making purchases and building credit

A secured credit card also works just like any other credit card in terms of your ability to make in-person and online purchases, except that the credit limit for a secured card is restricted by the amount of your cash deposit.

With a secured card in your wallet, you can start building a credit history from the ground up, or begin rebounding from a bankruptcy or another financial setback.

“As long as the issuer reports your payment history, you’re on your way to a better credit score,” Harzog says. “To boost your score more quickly, keep low balances and pay your bill by the due date.”

Bankruptcy and secured credit cards

If you’ve declared bankruptcy, Harzog points out that some card issuers won’t approve you for a secured card until a certain amount of time has passed — perhaps a year — since the bankruptcy was discharged, meaning you’re no longer required to pay the debts included in the bankruptcy case. However, other card issuers might overlook a recent bankruptcy, she says. Reach out to issuers to find out what their rules are regarding bankruptcies.

Some issuers don’t run credit or employment checks for secured-card applications, so a past bankruptcy might not even matter.

What to look for

Since you’re seeking to improve your credit history with a secured credit card, make sure the card issuer you pick reports your credit activity — such as whether you’re making on-time payments — to all three of the credit-reporting bureaus, says credit specialist Julie Marie McDonough, author of “How to Make Your Credit Score Soar.” The three bureaus are Equifax, Experian and TransUnion.

Activity tied to debit cards and prepaid cards isn’t reported to the three credit-reporting bureaus.

Aside from finding out about credit-reporting practices, McDonough and other experts recommend paying close attention to fees and other costs — especially the annual percentage rate (APR) — for any secured credit card you’re considering. Many secured credit cards charge higher fees and higher APRs than unsecured cards do.

Moving to the next level

Once you’ve qualified for a secured credit card and you’ve assembled a positive payment history, the issuer might bump up your credit limit. After six to 12 months of good behavior, you typically can graduate to an unsecured no-deposit credit card, Adams says.

If you do decide to step up to an unsecured card and cancel the unsecured card, your deposit is supposed to be refunded.

Remember, though, that the card issuer can tap into your deposit if you’ve failed to make a payment, according to Adams. Some deposits earn interest like a savings account does.

My application was rejected — now what?

Unfortunately, not everyone is approved for a secured credit card.

So, why would you be rejected?

You might have an error on your credit reports that’s damaging your credit history, for example, or your credit score might be too low. In those cases, you can contact the credit-reporting bureaus to fix the error, and you can work on boosting your credit score (like taking out a credit-building loan).

A card issuer also might have turned down your application because your income is too low or you’ve got a track record of making late payments on bills.

Once you’ve cleared up the issue that triggered the rejection, then you can reapply for a secured credit card.

Just remember that you shouldn’t apply for too many cards around the same time. Why? Each application shows up as a “hard inquiry” on your credit reports and might signal that you’re a high-risk borrower who’s experiencing severe financial trouble.

Bottom line

A secured credit card can be your gateway to building a credit history and, at some point, qualifying for an unsecured card, car loan or home mortgage. But that gateway can be blocked if you don’t treat your secured card with care, such as always paying your bills by the due date and always keeping your monthly balances low.

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John Egan

John Egan is a freelance writer, editor and content marketing strategist in Austin, Texas. Aside from PrimeRates.com, his work has been published by CreditCards.com, Bankrate, Credit Karma, LendingTree, PolicyGenius, HuffPost, National Real Estate Investor, Vitacost, SpareFoot, LawnStarter and other online outlets. He earned a bachelor’s degree in journalism from the University of Kansas and a master’s degree in communications from Southern New Hampshire University.