If credit cards were bicycles, secured credit cards would be a set of trusty training wheels.
Related article: How to Get a Secured Credit Card: Your Best Options
Sure, they don’t do much for your street cred and you certainly don’t want to be stuck with them for life; but they provide a safe way to learn how to manage your credit. They can also help you build or repair your credit score before you qualify for a big boy’s credit card.
So what is the difference between secured credit cards and regular credit cards?
Regular credit cards are unsecured loans or lines of credit. This means credit card companies don’t require you to place a collateral to secure the loan, as you must do to qualify for a mortgage or a car title loan. Instead, regular credit cards are based entirely on your good credit history.
If you don’t pay your credit card debt, the credit card company will report you to the credit reporting agencies and your credit score will plummet, but that’s all they can really do. Nobody is going to evict you from your home, repossess your car or garnish your wages. They basically lend you the money in the hope that your good name and the threat of ruining your credit, which amount to the same thing, will be enough incentive for you to repay your debts.
Secured credit cards, on the other hand, only offer a secured line of credit. This means the amount of money you can borrow on a secured credit card is dependent on how much cash you give as a deposit to the financial institution issuing the credit card.
Most secured credit cards will allow you to borrow as much money as the value of your security but some will only give you a credit line of 70% to 90% of your deposit.
With a secured credit card, you are effectively lending money to yourself and, if you carry a balance, paying interest on a loan you made to yourself! This is a great deal for banks but a terrible one for customers. See why most people switch to regular credit cards as soon as they can?
Benefits of Secured Credit Cards
So why would anybody want a secured credit card. If you already have the cash to place the deposit, why do you need the card? Secured credit cards are used by people who don’t have the credit to qualify for a regular credit card. Credit card companies use them to evaluate the financial habits and trustworthiness of customers.
If after six to 12 months you have used your secured credit card regularly and made all your monthly payments, most credit card issuers are willing to upgrade you to a regular unsecured credit card.
The credit card company may also report you to the credit reporting bureaus (Equifax, Experian and TransUnion) every time you make a payment on time. This helps build your credit history and your credit score will improve. Credit card companies are not legally required to report to credit reporting bureaus, so make sure your credit card issuer promises to do this in writing before you apply.
Secured credit cards are also a useful tool for people who don´t trust themselves, or their loved ones, with a large line of credit but still want the convenience of paying for things with plastic. For instance, by fronting the security deposit for your son’s secured credit card you’re giving him the convenience of a credit card and a head start toward building his own credit, without having to cosign on a credit card agreement.
Don’t confuse secured credit cards with prepaid debit cards, which provide the convenience of paying with plastic, but are not considered credit cards and will not help you build or repair your credit.
A Starter Card for a Real Credit Card
Like using training wheels when you’re learning to ride a bike, there’s no shame in having a secured credit card. They are the smart way to go if you need to build or repair your credit history. Having said that, most people should switch to a regular credit card as soon as they can.
Secured credit cards don’t usually have rewards programs and those that do are pretty lame. As soon as you qualify, apply for a credit card that will reward you for every dollar you spend. Here are the best cards of 2014 to get you started.
Andrew is the Content Director for SuperMoney, a Certified Financial Planner®, and a Certified Personal Finance Counselor. He loves to geek out on financial data and translate it into actionable insights everyone can understand. His work is often cited by major publications and institutions, such as Forbes, U.S. News, Fox Business, SFGate, Realtor, Deloitte, and Business Insider.