If you have bad credit, a secured credit card can be a great way to improve your score. Secured cards work the way regular credit cards do: You charge purchases to your account, make monthly payments and pay interest on balances you carry from one month to the next.
But there’s one major difference. You have to make a deposit to receive a secured card. This deposit protects the card issuer in case you don’t make your payments — and makes it easier for people with poor credit or a short credit history to get approved.
How the security deposit works
When you rent an apartment, you give the landlord a security deposit, which he or she can use to pay for repairs of any damage you might leave behind. Deposits on secured credit cards are similar: You provide a certain amount of money as collateral, and the credit card issuer usually gives you a credit limit equal to your deposit. For example, if you make a $500 deposit, your credit limit will also be $500.
When your lease is up, if your apartment is still in good shape, your landlord will refund your security deposit. Likewise, if you make on-time payments on your secured credit card, you’ll get your deposit back when you close or upgrade your account.
Find the right card
If you’re getting a credit card to fix your bad credit, choose one that reports to all three credit bureaus. Not all cards do. If your card issuer doesn’t report, you won’t improve your credit, no matter how faithfully you make your payments.
» MORE: NerdWallet’s best secured credit cards
The application process
Even though you’ll put down a security deposit, you won’t automatically be approved for a secured card. You still have to apply, and most of the time, the issuer will check your credit. Each credit check resulting from a credit application lowers your credit score a bit, so it’s not a good idea to apply for too many cards. If you’ve been rejected by a few issuers, explore other options. If you have a very low score, you may want to look for a card that doesn’t require a credit check at all — and there are a few.
» MORE: I was denied a secured credit card. What do I do?
Use your card the smart way
To improve bad credit, always make payments to your secured card on time and use only a small percentage of the credit extended to you. Don’t assume that your credit card company will use your deposit to cover any of your payments — secured cards aren’t the same thing as prepaid debit cards. Skip a payment, and you’ll end up with late fees and a negative on your credit report.
Level up
After your credit score has improved, you may want to close your secured credit card and switch to an unsecured card — one with a higher limit that doesn’t require a deposit. If you’re thinking of doing this, call your credit card company and ask if it will upgrade you to an unsecured card. If you have a good payment history, the answer may well be “yes.”
If you choose to close your secured card, call your credit card issuer to request that it close your account and refund your security deposit.
This article has been updated. It was originally published Dec. 12, 2014.
Lindsay Konsko and Virginia C. McGuire are staff writers at NerdWallet, a personal finance website. Email: lindsay@nerdwallet.com and virginia@nerdwallet.com. Twitter: @lkonsko and @vcmcguire.
Image via iStock.
from NerdWallet
https://www.nerdwallet.com/blog/credit-cards/how-secured-credit-cards-work/
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