A Secured Credit Card is a type of credit card that requires the cardholder to make a cash deposit as collateral, which serves as a security for the credit limit offered. This deposit reduces the risk for the credit card issuer, making secured credit cards an accessible option for individuals with poor or no credit history.
How Secured Credit Cards Work
Collateral Requirement
The collateral for a secured credit card typically corresponds to the credit limit. For example, a cardholder who deposits $500 would generally receive a $500 credit limit. This deposit is refundable if the account is closed while in good standing.
Issuer Protections
Issuers are protected from default risk using the deposit. If the cardholder fails to make payments, the issuer can recoup losses from the security deposit. This makes secured credit cards less risky for financial institutions compared to unsecured credit cards.
Benefits and Drawbacks
Benefits
- Credit Building: A primary benefit of secured credit cards is that they provide an opportunity to build or repair credit. Responsible use is reported to credit bureaus, which can improve credit scores.
- Approval Odds: Secured cards are easier to obtain than unsecured cards, making them accessible to individuals with subpar credit scores.
- Potential for Upgrade: Many issuers allow cardholders to transition to an unsecured card after demonstrating responsible use over time.
Drawbacks
- Collateral Requirement: The necessity of an upfront deposit can be a barrier for those who cannot afford it.
- Fees and High Interest Rates: Some secured credit cards come with various fees and higher interest rates, potentially increasing the cost of borrowing.
Examples and Applications
Practical Example
Consider a person named Jane who has a credit score of 550. She applies for and receives a secured credit card with a $300 limit, which corresponds to her $300 deposit. By making timely payments and keeping her balance low, Jane improves her credit score over time, eventually qualifying for an unsecured credit card.
Historical Context
Secured credit cards have been a part of the financial landscape for decades, introduced primarily to help individuals build or rebuild their credit profiles. They have grown in popularity as financial literacy has increased and more consumers seek ways to establish creditworthiness.
Comparisons with Related Terms
Secured vs. Unsecured Credit Cards
- Security Requirement: Unsecured credit cards do not require a deposit, whereas secured credit cards do.
- Credit Access: Secured credit cards are easier to obtain for those with bad credit, unlike unsecured cards that require a higher credit score.
- Cost: Unsecured cards often have lower fees and interest rates than secured cards.
Related Terms
- Credit Limit: The maximum amount a cardholder can borrow on a credit card.
- Credit Score: A numerical expression representing a person’s creditworthiness.
- Deposit: A sum of money placed as collateral for the credit card.
FAQs
Can I get my deposit back?
Will using a secured credit card improve my credit score?
Are there fees associated with secured credit cards?
Summary
A Secured Credit Card is a beneficial financial tool for those with poor or no credit history, providing a means to establish or rebuild credit through a deposit-backed credit limit. Though requiring a security deposit and often subject to higher fees, secured credit cards can pave the way for improved creditworthiness and financial stability.
References
- Federal Deposit Insurance Corporation. “Credit Cards and Credit Scores.” FDIC, 2021.
- Consumer Financial Protection Bureau. “Building Credit with a Secured Credit Card.” CFPB, 2022.
