Are you looking into getting a credit card? If you’re a student or stepping into the workforce on your first job, then chances are lenders keep turning down your credit card application. People who have no credit history, such as young adults, have no track record the lender can rely on to judge your level of creditworthiness.
This situation makes it risky for the lender to take a chance on you.
What if you don’t pay back to money you owe on your credit facility? As a first-time credit card owner, you may get caught up in access to the facility, overspending what you can afford to repay. It’s for this reason that most lenders, especially banks, won’t consider you for a credit card facility.
They want to see you build some form of credit history with a decent FICO or VantageScore before they approve you for a credit card.
However, you may have read or heard about secured credit cards. Lenders issue these “credit cards” to clients, in the hope that they can prove themselves responsible enough to manage debt.
So, what is a secured credit card? How does it differ from a standard credit card?
This article will breakdown everything you need to know about this credit facility, and how you can use it to build both your credit score and your creditworthiness with the bank.
What is a Secured Credit Card?
A secured credit card facility works the same way as a regular credit card. You take the card and swipe it in-store for purchases, or use it online at your favorite retailer. The card comes backed by Visa, MasterCard, or American Express as you would expect with any other credit card facility.
There is only one primary difference between a secured credit card and a standard card facility. When you get approved for a standard credit card facility, the lender approves you for a limit based on your income and credit score. Some lenders may also take into account your history with their financial institution when deciding on your credit limit as well.
However, with a secured credit card, you have to put a deposit down with the bank when opening the facility. If you want a $2,000 limit on your card, then you’ll need to place a $2,000 deposit with the bank before they issue you the credit card.
This deposit acts as “security” on your facility. If you fail to meet your monthly payments to the lender, then they seize your collateral to pay the debt. In essence, this makes the card similar to a debit card, but the bank is watching how you manage the credit line.
Depending on the terms involved with the facility, the bank may want you to manage your secured card for up to a year before they issue you a standard credit card facility.
Secured credit cards are an excellent way to build your credit score, and every time you pay off your outstanding balance, it’s reflected in your FICO or VantageScore. Likewise, if you fail to meet your financial obligations to the lender, then you can expect your non-payment to reflect in your credit score.
What You Need to Know About Secured Credit Cards
It may seem like applying for a secured credit card is a no-brainer for any newcomer to the financial sector. While there are tremendous advantages to starting your credit history with a secured card, there are some drawbacks to the facility, as well information you need to be aware of before you decide to apply.
Here are a few points to consider before you fill out your application with a lender.
No Guarantee Lenders Accept Your Application
When you apply for a secured credit card facility, the lender asks you to make a deposit equivalent to the credit line you’re requesting. You may think that because you are placing a deposit on the account, the lender will accept your application with open arms.
However, the truth of the matter is that the lender is not as quick to issue you the card as you think. Each financial institution offering secured credit cards has qualifying criteria you’ll need to meet for them to approve your account. All lenders have different rules for a successful application.
For example, if you’ve previously filed for bankruptcy, then some lenders will not consider your application, while others do not take this as a concern. Before you apply for a secured card, and waste your time, look at the terms and conditions provided by the lender on their website to ensure you are eligible.
Lenders Will Look at Your Credit History and Finances
Because you’re putting down a deposit with the lender that’s equivalent to the credit line you’re requesting, you may think that your current financial position and credit history won’t play a role in your application. Unfortunately, both of these factors play a significant role in the approval of the facility.
Banks have policies and procedures in place to check the financial health of any applicant looking to acquire a secured credit card. When considering your application, the lender pulls up your credit report to check on your past financial history. This check is a “hard inquiry” into your credit history — any hard inquiry results in the reduction of a few points from your credit score.
This hard inquiry may not make a difference for young people starting on their financial journey. However, if you are in your early twenties, then your credit score may be floating on the borderline of 580. A hard inquiry may reduce your score, making you ineligible for the secured credit card, even when putting down a deposit on the facility.
Not all lenders require a hard inquiry on your credit report when considering you for a facility. Therefore, it’s a prudent strategy to call the customer service branch of your preferred lender and ask them if they check credit scores when you apply.
The Card Shows Up as a Secured Credit Card on Your Credit Report
After you receive your secured card, you can use it, in the same manner, you would use an unsecured card. Retailers and merchants will not know that the card is secured, and you benefit from the social prestige of being a credit cardholder in the eyes of the economy.
However, anyone that checks your credit report will see that it’s a secured card. The card issuer codes the information on your facility into the data it reports to the credit bureaus. It’s important to note that when calculating your credit score using the FICO or VantageScore systems, the bureaus are only interested in your payment activity and behavior with the card.
When calculating your credit score, the bureaus are most interested in your “utilization ratio” more than they are with how you spend the money. The utilization ratio is the percentage of outstanding debt you have on the card; versus the amount of credit, you have available. If you’re getting a secured card in the hopes of improving your credit score, then you’ll need to keep 70-percent of your balance available at all times.
Read our Guides to Credit Scores:
- 5 Ways to Easily Check Your Credit Score for Free
- How to Repair a Bad Credit Score: Complete Guide
- Lexington Law Review: Complete Guide to this Credit Repair Company
Your Deposit Is Not a Safety Net
Many secured credit card owners make the mistake of thinking that their security deposit on the facility acts as a safety net; this is not true. The lender keeps the funds in a separate account to cover their risk, and returns it to you when you close the facility.
Don’t expect that if you can’t make the minimum payment on your card at the end of the month, that the bank will forgive you and deduct the outstanding amount from your deposit. The secured facility works in the same manner as an unsecured card, and you are liable for the minimum payment amount at the end of the month. If you fail to meet your payment obligations, the bank will report you to the credit bureau and close your facility.
In such a case of default, the lender deducts any leftover amount from the security deposit and returns the rest to you. However, you’ve blown your chance at any financial institution ever issuing you’re a card in the future, as it will be a permanent stain on your credit report.
Secured Cards Place You in a Position to Apply for an Unsecured Card
Some lenders will “graduate” you automatically from a secured to an unsecured facility after a given period. This graduation facility may differ from lender to lender, so always enquire about this period when you apply.
Some lenders do not automatically graduate your account, and you may have to reapply for an unsecured facility after the closure of your secured card.
Secured Cards Have Unfavorable Terms
When applying for a secured credit card, the lender takes into account your current credit score and past financial history. You’ll need to provide proof of income in the form of salary slips of tax returns to satisfy the risk management procedures of most lenders as well.
Since most people that apply for secured cards have no financial history or previous problems with their credit, the bank views them as “high-risk.” High-risk individuals should expect the lender to stick them with unfavorable interest rates on their credit facility.
Fortunately, the Credit Card Act states that no lender may issue an unsecured or secured credit card facility with fees higher than 25-percent of the credit line. This act helps to protect consumers from predatory lenders that issue cards with extortionate fees. However, banks being banks, they are most likely to charge you the maximum possible, so prepare for a 25-percent.
Fortunately, the act also prevents lenders from raising rates on any new transactions for the first year of the facilities use. The lender cannot raise the APR on the facility until the expiration of the teaser rate, the card has variable rates, or the cardholder misses two concurrent monthly payments. The act also ensures that lenders cap late fees, and if your lender wants to change your APR, then they must provide you with a written warning, two months in advance, as per the act.
Our Guides to Other Types of Credit Cards
Shop Around for the Best Lender
When applying for a secured credit card facility – it pays to shop around before you commit. Always look at the upfront and annual fees on offer by the lender. Ask your potential lender if they charge for these fees on your first statement, or if they subtract them from the deposit on your account.
Lenders vary in their internal policies, so – don’t take one lenders terms as a blanket for the industry. We suggest that you look into lenders that offer to subtract the fees from your deposit, allowing your cash flow some breathing room when setting up the account.
Annual fees may differ widely from lender to lender, so – make sure that you have a firm understanding of the terms and conditions on your account before you sign and submit your deposit.
The Lender May Not Report Your Activity to the Credit Bureau
One of the most attractive features to opening a secured credit card facility is that you improve your credit score every month when you pay your outstanding balance on time. However, it may surprise you to learn that some lenders do not report the activity on your account to the credit bureaus.
Most lenders may report your activity on the account to only two of the three credit bureaus, while some lenders may only file a report every quarter. Some lenders may not report your payment behavior at all, leaving you in a pointless position if you are trying to use a secured card to build your credit score.
However, you can rest assured that every lender will report non-payment or slow-payment on your account.
Therefore, you must enquire about the lenders reporting before you commit. Look for a lender that reports to all three bureaus every month, and you’ll be on your way to building a solid credit score.
Wrapping Up – Are Secured Credit Cards Right for You?
Secured credit cards can significantly benefit individuals who are looking to improve their credit score.
Your FICO or VantageScore determines your financial future, and building your credit through these vehicles will help you when it comes time to apply for a car loan or mortgage.
However, if you are irresponsible with debt, and have yet to understand the nuances of how finances work, then it’s best to avoid this facility.
The last thing you want is to receive a blemish against your name that could be detrimental to your future financial health.