What does “secured” mean exactly? Here’s everything you need to know about secured credit cards and how they can help you.
Secured accounts are something I talk quite a bit about. However it’s not uncommon for me to receive responses from people asking what is a secured credit card and how does it work. Well, here are the answers…
What does it mean?
In banking, the definition of “secured” refers to lending that is backed by the customer’s collateral.
For example, when you take out a mortgage, it’s a loan that is secured by the property’s title (the collateral). Until you pay off 100% of a mortgage, the bank is actually the owner of the house. Afterward, the title is transferred to the owner.
What does a secured credit card mean? That the account is backed by collateral – typically in the form of a cash security deposit. For example, a person might put up a $2,000 security deposit and in return, receive a $2,000 credit limit on their card.
Obviously this is much different than how traditional credit cards work. With those, you don’t have to put up any collateral. Your approval and line of credit is based solely on your creditworthiness. They are unsecured.
What are the qualifications to get one?
Unlike a regular credit card, with a secured account you can get approved even if you have awful credit or not credit history at all.
The reason is because you are the one underwriting the risk. The bank really has nothing to lose, because if you stop paying your bill, they can just deduct the amount from your security deposit.
Because a fully secured credit card is almost risk-free for a bank, usually they will approve nearly anyone who applies. Here are the minimum requirements you will typically see:
- Be at least 18 years old.
- Be a U.S. resident with a Social Security number (alternately, if you are an immigrant, then you must have a legal tax ID number in the US).
- Be ready to fund the security deposit. The minimum will usually be around $200 to $500.
The one thing you won’t see listed under the requirements is your creditworthiness… because good credit is not required! In fact even if you have the worst credit imaginable, you can still apply for a secured credit card.
There is one situation though where you should not apply and that is if you are currently going thru active bankruptcy proceedings. If you are in the middle of filing for bankruptcy, you will have to wait until that process wraps up. After that, you are free to apply.
How does it work?
A secured card works just like an unsecured card. The only difference is that you have to open it with a security deposit for collateral.
Step One: Opening the account
The application is very straightforward. You will fill out some basic info about yourself such as your name, address, date of birth, SSN, etc.
Some issuers will also ask for employment and bank account information. Typically, that’s only done if they are evaluating you for more than one card type (for example, if your credit checks out as being okay, some issuers might instead offer you a partially secured or fully unsecured card).
On the application they will ask how you would like to fund your deposit. There will be a few different options:
Your security deposit is fully refundable! In the future when you’re ready to close this credit card, you will receive back your full deposit. But if you owe a balance or fees when you close your account, then those will first be deducted from your deposit before it is given back to you.
Step Two: Using the account
If you’re familiar with how a regular credit card operates, this isn’t any different:
- You have the ability to spend up to whatever your credit limit is. Since this is a secured account, your credit limit will be the same amount as your security deposit.
- Your billing cycle is 30 days. At the end of each cycle, you will be mailed a statement for the purchases made during that time. If you pay back the full amount within 21 days from the statement date, no interest will be charged. If you pay less than the full amount (like the minimum amount due) then you will be charged interest. Those interest charges will show up on the following statement.
- Your account activity will be reported to the credit bureaus and will show up on your report just like how a normal credit card would.
Step Three: Upgrading or applying for a new card
Assuming you pay your bills on time and use the account responsibly, after 9 to 12 months you should consider applying for a beginner’s unsecured card.
Alternately, some secured cards will eventually let you “graduate” to an unsecured account. However the problem is that many of them won’t offer to do this for at least 2 years. That’s too long in my opinion! So instead, what I recommend is applying for an entry-level unsecured card after 9-12 months. If you get denied, wait another 6 months and try again.
Who should apply for one?
Why would you get and use a secured credit card versus an unsecured one? Here are 3 categories of people who should consider them.
- People with a bad credit history. Do you have a history of late payments and bills that have gone on to collections? If so, it’s going to be extremely hard for you to get approved for an unsecured card.
- People with no or limited credit history. If you’re in college, then you can get a student card even if you have limited history. But after college, it’s extremely hard to get approved for an unsecured account without a credit history.
- People who have a tendency to get into debt. If you have are worried that having a regular credit card will lead to debt, then it would probably be best to avoid getting one. But if you want a card solely for the purpose of building credit, then a secured one is a good choice since you won’t be able to spend more than your security deposit.
If you fall into any of those categories, then it makes sense to go the secured route.
Hopefully after reading all of the above, I’ve answered what a secured credit card is. But if you have any additional questions, feel free to leave them in the comments below.