If you are ready to re-enter the credit world after bankruptcy, foreclosure, or digging yourself out from a mound of debt, it might be time to get a credit card. If you can't qualify for a regular credit card, you might consider getting a secured credit card. Read on to learn more about secured credit cards, including how to get one.
(For other ways to improve credit, see our Rebuilding & Improving Credit topic.)
Many people with poor credit histories are denied regular credit cards. If your do apply for a regular credit card and your application is rejected, consider whether you truly need a credit card. Millions of people get along just fine without them.
However, if you decide that you really need a card -- for example, you travel quite a bit and need a card to reserve hotel rooms and rent cars -- then a secured credit card might be a good option.
With a secured credit card, you deposit a sum of money with a credit union or bank and are given a credit card with a credit limit for a percentage of the amount you deposit—as low as 50% and as high as 120%. Depending on the credit union or bank, you’ll be required to deposit as little as a few hundred dollars or as much as a few thousand.
Caution. Some secured credit card issuers ask you to put up your home as collateral. Don't do this. If you do opt for a secured credit card, make sure it isn’t secured by your home. If it is, and you get behind on your card payments, you could lose your home.
If you have a choice between a secured credit card and a regular credit card, a secured card is usually not the best choice. Here's why.
Unfortunately, secured credit cards can be expensive. Many banks charge hefty application and processing fees in addition to an annual fee. Also, the interest rate on secured credit cards may be as much as 20% or so; and your deposited money will earn, at most, the rate that the credit union or bank pays on its savings accounts, which currently may be less than 1%.
Some banks have eliminated the grace period—that is, interest on your balance begins to accrue on the date you charge, not 21 days later. If you find a card with a grace period and pay your bill in full each month, you can avoid the interest charges.
Credit unions routinely offer secured credit cards. Because they operate under different rules from banks, their fees may be lower than bank fees.
Another downside of secured credit cards is that some creditors don’t accept or give much weight to credit history established with a secured credit card. Ask the card issuer if it reports to the three nationwide credit reporting agencies (Equifax, Experian, and TransUnion). If the issuer doesn’t, you’ve lost an important benefit of having a secured card. Some smaller issuers don’t report to the credit reporting agencies, but most major banks do. Also ask if the card issuer will note that the card is a secured card when it reports to the credit reporting agencies. If it does, having that card may not be as helpful in establishing credit.
Many secured credit cards have a conversion option. This lets you convert the card into a regular credit card after several months to a year if you use the secured card responsibly. Because regular credit cards typically have lower interest rates and annual fees than secured credit cards, it’s usually preferable to obtain a card with a conversion option.
Use the secured credit card to make small purchases that you can pay off within the grace period each month. Always pay on time. This will help you build your credit. After you pay on time for a year, you may be able to qualify for an unsecured credit card with a lower interest rate. At that point, see Applying for an Unsecured Credit Card to get the best card you can qualify for.
Be careful searching for secured cards. Fees can vary dramatically, and there are numerous outrageously overpriced credit cards and outright scams. Ads also frequently mislead consumers into thinking that their line of credit will be higher than it actually is.
And be aware of secured credit cards that can be used only to purchase merchandise from the card issuer’s catalogue. The merchandise often is shoddy and high priced, and the issuer probably won’t report your charges and payments to the credit reporting agencies, so it won’t help you reestablish good credit.
Keeping these warnings in mind, here's where to start looking for a secured credit card:
Learn more about credit reports, credit scores, and repairing credit.
This is an excerpt from Credit Repair, by Margaret Reiter and Robin Leonard (Nolo).