What Is a Secured Credit Card and How Does it Work?

woman holding credit card

Secured credit cards are similar to regular credit cards, but require a cash deposit and are primarily used to help borrowers build or rebuild their credit. If you’re starting to build your credit history or have a low credit score, you’re likely still eligible because you’re borrowing against your own deposit.

Otherwise, secured cards function identical to a normal credit card, meaning you can make purchases at most retailers and payments are due monthly. In general, secured credit cards have higher interest rates than unsecured cards. Some people might look at a secured credit card as a prepaid card. 

As long as the card company reports to the three major credit bureaus, your activity with the new card appears on your credit report. Building creditworthiness with on-time payments will help improve your credit score. If you’re unable to make payments, the security cash deposit is used to settle the debt.

typical traist of a secured credit card

Who Uses a Secured Credit Card?

If you’re a teenager, student, immigrant or new to borrowing, it can be difficult to get approved for a regular, unsecured credit card. A secured credit card is a great way to start, and you can later switch to an unsecured credit card once you’ve established a credit line.

You might also try a secured card if you have a poor credit history. As long as you keep up with repayments, you can likely improve your credit score within six to 12 months. 

people who may benefit from a secured card

How Does a Secured Credit Card Work?

After putting down a cash deposit, a secured credit card can be used for normal purchases like shopping, gas and paying utility bills. If the balance is paid off each month, there are no interest charges. 

Here are a couple of things to note about secured credit cards:

  • In most cases, the cash deposit equals the amount you can borrow—otherwise known as your credit limit. For example, to get a card with a credit limit of $300, a deposit of $300 is likely required. In some cases, the deposit is less than your limit.

    The credit limit on secured credit cards is generally lower than unsecured cards, ranging from $200 to $1,000 on average, while some go as high as $10,000.
  • A secured card’s interest rate—also known as its annual percentage rate (APR)—is typically higher than that of an ordinary card.

    It’s often above 20%, but even so, there are some reasonable rates available. As with unsecured cards, if you pay off your balance in full at the end of the month, you won’t need to worry about paying any interest.

Secured credit cards are issued by the same financial institutions as regular cards, including online banks and dedicated credit card companies. Most secured credit cards have a small annual fee or no fee at all to keep your account open. 

Some have introductory bonuses and perks that match the cash earned in the first year. 

Before applying for a secured credit card, review the eligibility requirements, fees and interest rates to determine the best one for you. 

Secured vs. Unsecured Credit Card

A secured credit card requires a deposit, while an unsecured credit card doesn’t. Both allow you to make purchases and pay monthly, but unsecured credit cards tend to have better terms overall.

That’s why if you start with a secured credit card, you’ll eventually want to transition to an unsecured credit card. You’ll see lower interest rates, higher credit limits and better rewards and perks. 

Here are some tips on how to transition from a secured card to an unsecured card.

  • Speak to your card issuer: The easiest way to transition to a new unsecured card is to ask your secured card issuer if they have one that’s available to you. Some credit card issuers will automatically screen you for an unsecured card after several months of on-time payments.
  • Have at least six months of payment history: You may want to wait to apply for an unsecured card until you’ve established a solid history of on-time payments with your secured card.

    This shows the lender that you’re not a credit risk. The longer you’ve been paying your secured card successfully, the more likely it is you’ll be accepted for an unsecured card.
  • Reduce your credit utilization: A common way to end up being rejected for credit is to have a high credit utilization rate. Credit utilization is the amount of credit you’re using out of the total credit you have available.

    Try to pay off as much of your debt as you can before applying for an unsecured card. Again, this illustrates to the lender that you borrow conservatively and are less of a risk.
  • Aim for a credit score that is above 650: Most lenders consider FICO® credit scores between 650 and 739 to be “good.” If your score is below 650, you may have a hard time transitioning from a secured to an unsecured card.
  • Be sure you’re ready to make the switch: Ask yourself if you’re ready to make the jump to an unsecured card. Are you budgeting properly each month? Are you sure you’ll be able to keep up with repayments?

    Missed payments on your new unsecured card could cause your credit score to plummet and undo the hard work you’ve put into building up your credit, so think carefully before going ahead
  • Wait before closing your secured card: Closing your secured card will impact your credit score. It might decrease the length of your credit history or increase your credit utilization.

    To be safe, wait until you’ve been accepted for your new card before closing the old one. When you close your secured card account, you’ll get your deposit back.
secured credit card verus unsecured credit card

Tips for Using a Secured Credit Card

Even though your secured card is backed by a deposit, don’t forget that you’re still borrowing money. If you fail to make the payments, you’ll be charged late fees and interest, and your credit score could be affected. Here are some tips for managing your secured card.

  • Make sure your payments are reported to the credit bureaus: There are three main credit bureaus in the United States: Equifax, Experian and TransUnion. Not all credit card companies report to all three, and you’ll need your score to be good on all of them. Before applying, see if the card issuer reports to all three.
  • Aim for regular card use: Using your card indicates to the credit bureaus that you can handle credit. Keep things manageable by making a few small purchases each month and paying them off.

    Monthly groceries and utility bills tend to be manageable on a secured credit card and will fall under your credit limit.
  • Keep your utilization low: Your credit utilization should be kept as low as possible to improve your credit score. The lower your utilization, the better. Ideally, your ratio should be less than 30 percent.

    If you can, pay your bill in full each month, or pay as much off as you can.
  • Make multiple payments within the month: There’s no way of knowing when exactly your credit card company sends information to the credit bureaus. Making several small payments throughout the month ensures you keep your balance low whenever the reporting is done.
  • Always pay on time: One missed payment can affect your credit report for as long as eighteen months and can be a setback to rebuilding your credit.

    If you’re worried you’ll forget to make a payment, set up alerts on your phone, or better still, pay automatically by direct deposit.
  • Make sure nothing harms your credit report: Avoid applying for other loans or financial agreements for at least three months. Check your credit report frequently for errors and fraudulent activity.

    If you see any errors, you’ll want to initiate a dispute as soon as possible.
  • Be wary of perks and bonuses: Some secured credit cards have appealing introductory offers and rewards. Be careful. Rewards and bonuses are designed to encourage you to spend. Don’t spend money on anything you wouldn’t normally buy.
secured credit card best practices

Secured Credit Cards: A Good Starting Point

When used wisely, a secured credit card can be an excellent way of building credit. It also allows you to learn how to use credit properly if you’re new to borrowing. But remember, a secured credit card is still a credit card.

If you’re considering applying for one, think carefully about whether you can make the payments before taking the plunge. If you’re trying to rebuild your credit, consider a credit repair consultation first.