Building Credit with a Secured Credit Card

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Building Credit with a Secured Credit Card

Aug, 8th 2016

Many of life’s daily activities – from renting a car to booking a hotel room to obtaining certain jobs – require that you have a credit card.

But what do you do if you’re just starting out in life and don’t have a credit history to back your desire for a card? Or worse, you’ve gone through some rocky financial times, but have emerged on the other side and need to rebuild your credit rating?

There is an answer. It’s called a secured credit card, and it’s a path toward normal credit status for a large number of individuals.

A secured credit card requires that you put up a cash deposit with your bank. Typically, that amount becomes the established credit line for the account. For example, if you deposit $500, you will have a $500 credit line. However, depending on the bank’s policies, you may be asked to deposit as much as $1000 for a $500 limit.

In some cases, you can add money to the initial deposit to extend the line, or the bank may allow a token $200 overage, providing actual credit.

From there, the deposit is held in a savings account and may, depending on your bank, earn interest (note – most do not). The key to the secured card is that your credit card activity will be reported to the three major credit bureaus, Experian, TransUnion and Equifax. The goal is to slowly rebuild your credit rating.

NUMBERS ARE CLOUDY

Secured cards first came on the scene in the late 1980s (actual credit cards date to the 1950s, with charge cards requiring full balance payoffs each month bowing in the 1940s). A U.S. recession in the early 1980s left many Americans outside traditional credit eligibility, creating the opportunity for the secured card.

Today, the number of secured credit cards circulating in the U.S. is hard to track. Some suggest that the total of secured cards is falling, as banks have become more comfortable dealing with lower credit lines on regular cards and tighter restrictions on customers.

But the Great Recession of 2008 made financial hardship no stranger to many Americans who still need some form of credit. And certainly the Baby Boom of the late 1990s is now entering the years where a card is a stepping stone to maturity. Given those two factors, it’s likely that card totals remain robust, and most banks will offer some form of secured card program.

The New York Times reported that the number of secured credit cards in circulation was expected to reach 1.2 million by 1995, up from just 145,000 in 1988. The number of institutions issuing the cards grew to 400 that year. Overall, the number of new bank credit cards issued was 28.8 million in the first half of 2014. This suggests that secured cards are somewhere around five percent of less of the market, and may be falling as more consumers use debit cards for their transactions.

As of 2014, the number of new cards given to consumers with credit scores of 660 or lower – considered subprime – was up 40 percent from the prior year. In the first quarter of 2015, the number flattened to levels roughly the same as the first quarter of 2014, but credit limits were tightened.

SMALL STEPS FIRST

If you pay your bills on time, don’t exceed your credit limits or use excessive amounts of your established credit line, you build trust with your banking institution and will see your credit score with the major bureaus inch upward. You may even be eligible for some of the perks offered to “regular” card holders at your bank, including discounts on shopping and points on purchases.

Eventually, if you maintain a good relationship, you can convert to a regular credit card and receive your deposit back, or switch banks and obtain a regular credit card. The key is establishing a positive credit rating, which determines the level of access you will have to higher credit limits and better interest rates.

If you stumble again on your payment schedule, the secured deposit won’t automatically be debited. It takes severe delinquency of three months or more before anything negative happens, although the interest and fees can continue to accrue. It also will not reflect well on your credit record if the delinquency inches into negative territory.

THE DOWNSIDE

Of course, there are objections to the secured card.

“It’s not really credit if I’m using my own money,” some say. That’s true, but the goal is to establish that you can responsibly manage money. In time, the bank may increase the credit line without the need for a further deposit, or may even convert the card to a non-secured line and refund your deposit. If you reach that status, you have proven you are credit-worthy. And from there, you can build up a track record that can result in increased lines of credit or even a home mortgage. 

There are other negatives with a secured credit card. The interest rates charged are typically higher, and fees associated with the card (including annual fees for merely holding one) may also be high. You also may not qualify for one if you have had a recent bankruptcy or outstanding liens.

When shopping for a secured card, look for a reputable bank. Bankrate.com offers a list of secured credit card issuers, and many other options abound. As with any business deal, it pays to be a careful shopper. Some secured card outlets may charge a fee to apply (avoid those) and others may impose onerous fees that can eat up your deposit with minimal usage. The amount of money needed to hold on deposit varies as well, and make sure that your bank reports to all three major credit bureaus, not just one.

It will take about a year of careful credit management to either establish your track record or return you to the good graces of most institutions. But it can be done, and with a secured card, you are taking a first step toward building a positive credit profile.

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