Secured Cards: What They Are and How They Can Help (Re)Build Credit

If you're new to credit or have made a few financial missteps in the past, getting approved for a credit card can be challenging. Unfortunately, building credit means using credit — which can leave you in a frustrating catch-22. That's where secured credit cards can come in handy.

Secured cards work just like traditional credit cards, with one exception: They require a refundable security deposit. A security deposit lowers the lender's risk, so secured cards can be easier to qualify for if you have limited credit history or a less-than-stellar credit score.

Here's the important part: Using a secured card responsibly can help you build a positive credit history and potentially qualify for better cards down the road.

Here's how secured credit cards work, what to look for, and how to use one to build or rebuild your credit.

Related: The Best Secured Credit Cards You Can Apply For

What Is a Secured Credit Card?

A secured credit card is a credit card backed by a cash deposit. That's the biggest difference between a secured card and a traditional unsecured card. With an unsecured card, you don't provide collateral before the issuer extends you credit. Instead, your approval and credit limit are based on factors such as your credit history, income, and existing debt.

With a secured card, you must provide a refundable deposit when you open the account, and the issuer holds it as collateral. That deposit will determine your credit limit. For example, if you put down a $500 security deposit, your credit line will also be $500.

The important thing to understand is that your deposit isn't money you use to pay your credit card bill. If you charge $100 to your secured card, you still owe the issuer $100. Your deposit generally sits untouched unless you default on the account.

Otherwise, a secured card works much like any other credit card. You can use it to make purchases, receive a monthly statement, and make payments toward your balance. And unlike a prepaid card or debit card, you're borrowing money from the issuer when you make a purchase. If the issuer reports your account activity to the credit bureaus, that borrowing and repayment history can help you build credit.

Related: What Is Considered a ‘Fair’ Credit Score — and How To Improve It

How Secured Cards Can Help Build or Rebuild Credit

A secured card isn't exactly a shortcut to a great credit score, but it can give you an opportunity to build a positive credit history. The key is choosing a card that reports your activity to the credit bureaus and then managing the account responsibly.

Your payment history is one of the most important factors in calculating your FICO credit score, so paying your bill on time every month can help you build a positive track record.

Credit utilization is also a major factor. Utilization measures how much of your revolving credit you're using compared with your available credit. Secured cards often come with relatively low limits, so utilization can climb quickly. For example, a $200 balance on a card with a $300 limit is nearly 67% utilization.

You don't need to put all that much spending on the card to build credit. One simple strategy is to charge one or two predictable expenses, like a streaming subscription or your phone bill, then set up autopay to cover the statement balance in full each month.

Building credit from scratch takes time. FICO generally requires at least one account that's been open for six months or longer and at least one account reported to the credit bureaus within the past six months before it can calculate a score.

How long it takes to rebuild existing credit depends on your overall credit profile and what's currently appearing on your credit reports.

Who Should Consider a Secured Credit Card?

A secured credit card can make sense in several situations. You might want to consider one if you:

• Have little or no credit history
• Have a low credit score and are having trouble qualifying for an unsecured card
• Are rebuilding your credit after missed payments or other negative marks
• Want to establish your own credit history rather than relying solely on authorized-user status
• Can afford to temporarily set aside money for the required security deposit

Secured cards aren't only for people repairing damaged credit. They can also be useful if you're just getting started and don't yet have enough credit history to qualify for more traditional cards. However, you'll still need to qualify for the card. A security deposit doesn't guarantee approval, and issuers could consider other information when evaluating your application.

What To Look for in a Secured Credit Card

Not every secured credit card is equally useful. Some are relatively inexpensive and great credit-building tools, while others pile on fees that can make them unnecessarily expensive. Before applying, you'll want to look at a few key features.

Credit bureau reporting

If your main goal is building credit, make this one of your top priorities. Look for a card that reports your account activity to Equifax, Experian, and TransUnion. If the issuer doesn't report your payments to the credit bureaus, responsible card use won't do much to help establish your credit history.

Security deposit

Find out how much you'll need to put down and how that amount affects your credit limit.

Many secured cards require at least a few hundred dollars upfront. While that money is usually refundable, you might not have access to it while the account remains secured. Don't put down more than you can comfortably afford to have tied up.

Fees

Ideally, look for a secured card with no annual fee. Also watch for application fees, monthly maintenance fees, and other charges. There are enough relatively straightforward secured cards available that you shouldn't assume paying a pile of fees is the cost of rebuilding your credit.

A path to an unsecured card

Some issuers periodically review secured accounts and eventually upgrade them to unsecured cards. That can let you keep the same account open while getting your deposit back.

Related: Can Opening a New Credit Card Actually Help Your Credit Score?

Rewards

Credit building should be your first priority, but rewards can still be a nice bonus. Some secured cards offer cash back on purchases. Just don't let rewards encourage you to spend more than you otherwise would. A few dollars in cash back won't offset the cost of carrying a balance and paying interest.

What Happens to Your Security Deposit?

Your security deposit won't be gone forever. Depending on the issuer, you could get it back when:

• Your card graduates from a secured card to an unsecured card
• You close the account with no outstanding balance
• The issuer otherwise determines you no longer need to maintain the deposit

Some issuers automatically review accounts for graduation, while others don't offer an upgrade path at all. And if your credit improves enough to qualify for a better card elsewhere, don't automatically close your secured account the moment you're approved. Check whether your issuer can convert the card to an unsecured account and return your deposit first.

Bottom Line

A secured credit card can be a useful stepping stone if you're building credit from scratch or rebuilding after past mistakes. You'll need to provide a refundable security deposit, and your initial credit limit may be fairly modest. But otherwise, the card functions just like a traditional credit card.

Choose a card that reports to the major credit bureaus, charges reasonable fees, and ideally offers a path to an unsecured account. Then focus on the basics: Pay on time, keep your balances manageable, and avoid carrying debt just for the sake of building credit.

A secured card probably won't be the most exciting credit card you ever open. But if you use it responsibly, it can put you in a better position to qualify for more rewarding cards later.