Credit Cards

What Is A Secured Credit Card And Who Should Use One?

| Last updated on October 8, 2019

Secured credit cards are a good way to build a solid credit history, especially for those with bad credit. The amount of money deposited for the card is the credit limit, so it’s impossible to go over-limit.

And since the cardholder provides a deposit, the interest rate charged is usually lower than for a non-secured card.

How do credit cards work?

They allow people to purchase items or services without paying the money right away. In some ways, they’re similar to loans. Companies limit the amount that can be borrowed (credit limit). Monthly interest charges are added to those purchases, unless the total amount is paid off at the end of the month.

The interest rate, or how much the company is charging you to borrow on the card, is based on your credit score (as is your credit limit). This calculation reflects how likely you are to have problems paying the money back. The higher your credit score, the less likely you are to have repayment issues.

The lower your credit score, the more likely you are to default, or not pay off your card. Because you’re a riskier bet, the credit card company will charge you a higher interest rate. That can make it even harder to pay off your credit card bills!

Credit scores are based on factors like late payments on (any) of your bills, how much debt you have compared to your income, how many credit accounts you have, and how much of your credit limit you’re currently using.

As you can see, credit is quite dangerous if you don’t use it responsibly!

Secured credit cards

These types of cards require a deposit. The amount of your collateral is your credit limit. Deposit $500, and you now have a credit card with a $500 limit.

In some ways, they operate like a regular credit card. You’ll still have to pay your monthly bills, because payments don’t come from the deposit. Interest is charged monthly unless you pay the balance in full at the end of the month.

However, the interest rate on your secured card will typically be much lower than for an unsecured one. The company is not taking any risk; if you don’t pay, then the deposit is theirs.

Secured credit cards are not the same as prepaid debit cards, even though a deposit is necessary for both. Just like other credit cards, the secured cards report into the credit bureaus. Staying current on the secured card helps you build good credit.

However, debit cards are not based on credit, so they don’t report in to the credit bureaus. They won’t help you with your credit score.

When you use the secured credit card, the person behind the counter or Internet store doesn’t know that it’s different. It behaves just like any other credit card. Only you and the company who issued it to you know there’s a deposit behind it.

Who should use a secured credit card?

The two main benefits to using a secured credit card are lower interest rates (for those with bad credit), and the ability to use it to develop or improve credit history.

In Canada, most negative credit events are removed from your credit report in six years. As long as you make payments on your secured card, eventually the bad credit drops off. Staying responsible with your secured card will help you build up a good credit score.

Many jobs these days require a credit report, and many landlords do as well. If you plan to buy a house, bad credit means your interest rate will be quite high. Assuming you can actually obtain a loan.

Building up your credit helps in many ways, not just for your credit cards!

Generally there are two types of people who are looking to build up good credit.

People with bad credit history

If you’ve never been taught the right way to use credit, having a credit card can get you into trouble pretty quickly! (Or if you ignore what you’ve been taught.)

It’s best to pay off credit cards at the end of the month. That way you won’t add to your debt load with more interest charges.

In other words, if you don’t have the cash to afford something, and you won’t have it by the end of the month, you shouldn’t buy it.

Practicing good habits with your secured credit card can eventually improve your credit score. Then, when you’re eligible for decent interest rates, you can get a regular credit card. As long as you’ve paid off any balances, most secured card companies will give you back your deposit when you close the account.

But what if you think you might get in trouble again with an unsecured card? Continue with the secured one, or use a debit card instead.

People with no credit history, often students

As noted earlier, there are many life necessities that require a good credit history. Such as a job or place to live. However, students (and/or their parents) may be wary of taking out a regular credit card. Especially given all the temptations to spend!

The secured card allows someone new to credit to practice good habits, like paying off all purchases at the end of the month.

It might help parents to sleep at night, knowing that their child can’t spend too much with the card.

Capably using a secured card builds a good credit history. Even for spenders, this type of card will help rein you in and avoid destroying your credit.

Do secured cards come with the same bonuses as regular ones?

Yes, some of these cards offer rewards points. Not all of them have this feature. Rewards are unlikely to be as generous as with a regular card.

Some of these banks even offer free financial education as a perk.

How do I get one of these fabulous cards?

Many Canadian banks offer a secured credit card. You can apply online, just as you would for any credit card. You’ll need to provide the deposit. In cash – no one will accept another credit card for this one!

Some companies require a certain amount, such as $200, for the security deposit. Look for a card that has no annual fee if possible, or at least a low one. You don’t want to fork out $50 a year for a $200 credit limit!

Should I get a secured credit card?

If for any reason you’re looking to build up good credit history, these cards can help you. Someone with no credit history can get a secured card and learn to use credit responsibly.

Those with bad credit benefit too. Because you pay the deposit up front, you don’t have to worry about increasing your debt. In addition, interest rates on unsecured cards for those with low credit scores are much higher. That makes paying off the debt much more difficult.

Don’t know if you can maintain good credit usage? Try out a secured credit card. If you can use credit responsibly, you’ll eventually switch to an unsecured card. If you can’t, this type of card can help you avoid making your credit worse.

Summary

Secured credit cards are “secured” with a cash deposit. This makes the holder less risky to the credit card company, so interest rates will be lower for those with bad credit history.

They offer the opportunity to build credit history and good credit habits, whether you have bad or no credit. Parents can rest easy knowing their child can’t run up a huge amount of debt, too.

Click here to check out the best secured credit cards in Canada.