Financial independence and security are paramount. From everyday purchases to occasional splurges, your financial journey starts with a solid credit history and a good credit score.
The credit options may be limited for individuals starting or rebuilding their credit. The concept of secured credit cards can bring hope to gain your footing and reach your financial goals.
But what exactly is a secured credit card, and how does it help individuals build credit? Why should you even care about building credit?
Your credit history is tied to your eligibility for several financial products, and a secured credit card is a simple way to help you improve it. We explore the world of secured credit cards, explaining what they are, the benefits, and how to build credit with a secured credit card.
We also discuss the application process for a secured credit card, what to consider when choosing one, and how to go from a secured to an unsecured credit card.
What is a secured credit card?
A secured credit card is a type of credit card offered by banks, credit unions, and other financial institutions. It requires a secured credit card deposit, which acts as collateral for the card. The collateral serves as a guarantee to the card issuer in case the cardholder defaults on card payments.
The amount of cash deposit determines the credit limit of the secured credit card. For example, a $500 deposit means you can spend up to $500 on your secured card.
Secured credit cards are designed for individuals with limited or poor credit history, as well as people looking to build or rebuild their credit. Since the cardholder provides a cash deposit, secured credit cards are typically easier to qualify for than traditional, unsecured credit cards.
While you need a cash deposit, a secured credit card works like any traditional one. Cardholders can make purchases, pay bills, and build credit history by using the card responsibly. It includes making timely credit statement payments, keeping balances low, and managing the card in a financially responsible way.
Financial institutions report the payments to credit bureaus, so effective credit management can help improve your credit score. It gives individuals the opportunity to access credit and build a positive credit history to gain future financing. As you show financial responsibility and establish a pattern of on-time payments, you may eventually qualify for an unsecured credit card with higher credit limits and more favourable terms.
How do secured credit card deposits work?
Secured credit card deposits serve as collateral and function as a security measure for the card issuer and cardholder. It lowers the risk of the credit card company to loan money to the borrower. Here's how the deposits typically work:
Initial deposit
When applying for a secured credit card, the card issuer requires an initial cash deposit from the cardholder. This deposit is collateral and determines the card's credit limit. The amount of deposit varies depending on the issuer and the specific card.
Deposit holding
The card issuer holds the deposit in a separate account, usually an interest-bearing savings account or a Certificate of Deposit (CD). The funds remain in the account if the cardholder has the secured credit card in good standing.
Security for the issuer
The deposit provides security for the card issuer in case the cardholder defaults on payments. If the cardholder fails to make payments as agreed, the issuer can use the deposit to cover the outstanding balance on the card.
Factors to consider when choosing a secured credit card
When choosing a secured credit card, you should consider several factors to ensure the card aligns with your financial goals and needs. Here are some factors to consider.
Security deposit requirements
The security deposit is collateral and represents your credit limit. Compare the minimum and maximum deposit requirements of different secured credit cards. Consider how much you're willing and able to deposit and whether the card's deposit requirements fit within your budget.
Credit reporting
Check whether the secured credit card reports your payment history to all three major credit bureaus. Credit reporting is essential for building or rebuilding your credit history effectively and improving your credit score.
Fees
Review the fee structure of the secured credit card, including annual fees, monthly maintenance fees, and other associated charges. Look for secured credit cards with reasonable fees or options to waive certain fees.
Interest rates
Compare the annual percentage rate (APR) charged on purchases, balance transfers, and cash advances. While secured credit cards often have higher APRs than unsecured cards, look for cards with competitive rates to minimize interest charges.
Credit limit and graduation
Consider whether the secured credit card offers the potential for a credit limit increase over time or the opportunity to graduate with an unsecured credit card. Transitioning from a secured to an unsecured credit card can provide access to higher credit limits, better terms, and more lucrative rewards.
Rewards and benefits
Some secured credit cards may offer rewards programs, such as cash back or points for eligible purchases. Evaluate whether the rewards and benefits align with your spending habits and preferences.
Customer service and support
Research the card issuer's reputation for customer service and support. Look for reviews and ratings from other cardholders, or ask your friends and family. Gauge the quality of service provided and see whether the card issuer offers responsive and thorough support to resolve complaints.
Credit building tools
Determine whether the secured credit card offers additional resources or tools to help you build or improve your credit. It may include access to credit monitoring services, educational materials, or credit score tracking. Credit-building tools are essential to keep you on the right track of improving your credit history.
Accessibility
Consider the accessibility and acceptance of the secured credit card. Ensure the card is widely accepted by merchants and retailers internationally and domestically.
Terms and conditions
Carefully read and understand the terms and conditions of the secured credit card before applying. Pay attention to restrictions, limitations, or fine print associated with the card.
Can I get my deposit back on a secured credit card?
You can typically get your deposit back on a secured credit card under certain conditions. Many secured credit card issuers offer the opportunity for cardholders to transition to an unsecured credit card after consistently showing responsible credit usage.
The credit card issue reviews your payment history, credit score, and overall financial behaviour. If you qualify for an unsecured credit card, the issuer may refund your deposit and convert your account to an unsecured one.
If you decide to close your secured credit card account, the issuer can refund your deposit, provided your account is in good standing and you don't have outstanding balances. However, closing a credit account may impact your credit score.
Some secured credit card issuers may offer upgrade options that allow you to switch to a different credit card without closing your account. The issuer may refund your deposit or apply it to the new card.
Contact the credit card issuer to request a refund of your deposit. They will guide you through the process and provide instructions on how to initiate the refund. Once your request is approved, the card company will return your deposit, typically by issuing a check or transferring the funds back to your account.
Minimum credit score for a secured credit card
The minimum credit score required for a secured credit card varies depending on the credit card company. Secured credit cards are typically designed for individuals with limited or poor credit history, so they may be more accessible for those with lower credit scores.
Some secured credit card issuers may have no minimum credit score requirement, making them available to people with no credit history, like students or newcomers. Instead of assessing creditworthiness using credit scores, the issuer may consider other factors like income, employment status, and the ability to provide a security deposit.
Even though secured credit cards are more accessible, a higher credit score may still improve your chances of qualifying for better terms, such as lower fees, higher credit limits, and rewards programs. If you're considering applying for a secured credit card, it's essential to research different issuers and their specific requirements. You may prequalify for secured credit cards online without affecting your credit score, allowing you to gauge your eligibility before applying.
How to apply for a secured credit card
Here's a step-by-step guide to help you navigate the application process for secured credit cards:
Research and compare: Start by researching different secured credit cards from various companies. Compare factors like security deposits, card fees, interest rates, credit reporting policies, and additional features.
Check eligibility: Review the eligibility criteria for each secured credit card you're considering to ensure you meet the requirements. While secured credit cards may be more accessible, you may still have certain income and age requirements.
Gather required documents: Gather the necessary documentation you'll need to complete the application. It typically includes personal details like your legal name, date of birth, Social Insurance Number, address, employment information, and income details.
Choose an issuer: Once you've selected the secured credit card you want, visit the issuer's website or a local branch to apply. You may also be able to apply for a credit card over the phone.
Complete the application: Fill out the application form accurately and completely. Provide all required information and double-check for errors before applying.
Submit security deposit: After submitting your application, you provide a security deposit to fund your secured credit card account. The deposit can usually be made online, by mailing a check, or by visiting a branch location. The deposit typically becomes your credit limit.
Wait for approval: The credit card issuer reviews your application and determines your eligibility. Approval decisions may take anywhere from a few days to a few weeks, depending on the issuer's processing times.
Receive your card: If your application is approved, you'll receive your secured credit card in the mail. Follow the instructions to activate your credit card.
Start building credit: Use your secured card responsibly to make purchases and build a positive credit history. Make timely payments, keep your balances low relative to your credit limit, and avoid overspending to maximize the benefits of your secured card.
What's the difference between secured cards and unsecured cards?
Secured and unsecured credit cards differ primarily in how they are backed and the requirements for approval. Here's a breakdown of key differences to consider.
Security deposit
Secured credit cards require a cash deposit as collateral, typically equal to the credit limit. The deposit protects the issuer in case the cardholder defaults on payments. Unsecured credit cards don't require a cash deposit or any collateral. Approval is based on the applicant's creditworthiness, income, and other factors.
Approval process
Secured credit cards may be easier to qualify for, making them accessible to people with poor credit histories and those looking to build or rebuild credit. Unsecured cards may require a higher credit score and a positive credit history for approval because lenders have more risk. Issuers evaluate factors like credit score, income, employment status, and existing debts.
Credit limits
For secured credit cards, credit limits are often determined by the amount of the security deposit. The deposit may also influence the initial credit limit offered. Credit limits for unsecured cards are determined by the issuer based on the applicant's creditworthiness, income, and other factors. Higher credit limits are typically available to individuals with excellent credit scores and strong financial profiles.
Fees and interest rates
Secured credit cards may have higher interest rates and fees compared to unsecured cards, especially for individuals with lower credit scores. Common fees include annual fees, monthly maintenance fees, and higher APRs. Fees and interest rates vary for an unsecured card depending on the cardholder's credit profile. Individuals with higher credit scores may qualify for lower fees and APRs.
Credit building
Cardholders can use both a secured and unsecured credit card to build or rebuild credit by demonstrating responsible credit usage. Issuers typically report payment history to major credit bureaus, helping individuals establish a positive credit history over time.
Secured credit cards vs. prepaid credit cards
Secured credit cards and prepaid cards are both financial tools used to make purchases and manage expenses. A prepaid secured card works by loading and reloading money and paying for things as you would with a chequing account. However, prepaid cards work on credit card networks. Prepaid cards don't require a security deposit.
Prepaid cards typically don't contribute to credit building since they don't involve borrowing money or extending credit. However, the KOHO prepaid card can build credit with a line of credit from us or your own secured line of credit. Carefully weigh the features of secured and prepaid cards to determine which card fits your situation.
Transitioning to an unsecured credit cards
The transition from a secured to an unsecured credit card is a significant milestone for many people. It means you've demonstrated consistently good credit management skills and have likely improved your credit history and credit score.
To graduate with an unsecured card, regularly monitor your credit score to track your credit-building progress. You can request free credit reports from each of the major credit bureaus once a year. Many credit card issuers also provide free credit score reports through their online account portals.
Tips for using a secured credit card to build credit
Using a secured credit card strategically can be an effective way to build or rebuild credit. It improves your credit score and gives you access to better credit options and terms in the future. Here are some tips to maximize the benefits of secured credit cards:
Make timely payments: Pay your bill on time each month. Payment history is one of the most important factors in determining your credit score, so consistently making on-time payments can have a significant positive impact on your credit.
Keep balances low: Aim to keep your credit card utilization rate low, typically within 30% of your total credit limit. It shows you can responsibly manage credit and can help improve your credit score.
Pay your balance in full: Pay your credit card balance in full whenever possible. It helps avoid paying interest and demonstrates responsible credit behaviour.
Monitor your credit: Keep an eye out on your credit report to monitor changes to your score.
Use your card regularly: Use your secured credit card regularly for small purchases and pay the balance in full each month. Regular usage shows responsible credit management and helps establish a positive payment history.
Review your statements: Review your credit card statements regularly to check for unauthorized charges or errors. Reporting and resolving discrepancies promptly can help protect your credit and prevent potential issues.
Be patient and persistent: Building credit takes time, so be patient and persistent in your efforts.
Who should use a secured credit card?
Secured credit cards are great for several groups of people, including:
individuals with limited or no credit history
individuals with poor credit
students
newcomers
individuals recovering from financial setbacks
individuals rebuilding their credit scores
individuals building financial discipline
What are the alternatives to secured credit cards?
There are several alternatives to secured credit cards that individuals can consider, depending on their financial goals, credit history, and preferences.
Credit builder loans
Credit builder loans are designed to help individuals build credit from scratch or improve their credit scores. The borrower makes monthly payments into a savings account or certificate of deposit held by the lender. Once you pay off the loan, the borrower receives the funds.
Authorized user status
Becoming an authorized user of someone else's credit card account can help individuals build credit without the need for a secured credit card. As an authorized user, you can make purchases using the primary cardholder's account. The account activity may be reported on your credit report.
Credit union-secured loans
Some credit unions offer secured loans as an alternative to secured credit cards. With a secured loan, you borrow money and provide collateral, such as a savings account, to secure the loan. As you make payments on the loan, the activity may be reported to credit bureaus, helping you build credit.
Credit-builder secured loans
Credit-builder-secured loans are specifically designed to help individuals build credit. You borrow a small amount of money, which is typically held in a savings account or certificate of deposit until the loan is paid off. The payments are reported to credit bureaus, helping you establish a positive credit history.
Alternative credit cards
Some credit issuers offer alternative credit cards designed for individuals with limited or no credit history. These cards may have higher interest rates or fees but may be easier to qualify for without the security deposit.
Secured debit cards
Secured debit cards are similar to secured credit cards but function like traditional debit cards. Instead of borrowing money, you reload funds onto the card, and purchases are deducted from the available balance. While secured debit cards don't help build credit, they can be useful for managing expenses and budgeting.
Build credit with KOHO
Build your credit with KOHO to reach your financial goals faster. Whether you're going on vacation, paying for school, or getting your first car, you likely need some help with financing. A strong credit score can help you find better loans and terms.
Using a virtual credit card, you can develop good credit management skills and make on-time payments that are reported to the credit bureaus, all while earning cash back. Good credit management skills improve your credit history and credit score to help you secure financing.
We offer overdraft protection coverage, giving you peace of mind if case you go over your credit limit. Get up to $250 in interest-free cash advance for unexpected expenses that may arise. Unlock funds by making on-time payments and paying the overdraft subscription fee.
Learn more about KOHO's credit-building tools and expert advice to help improve your credit score or earn interest in a high-interest savings account to reach your financial milestones.
About the author
Grace is a communications expert with a passion for storytelling. This hobby eventually turned into a career in various roles for banks, marketing agencies, and start-ups. With expertise in the finance industry, Grace has written extensively for many financial services and fintech companies.
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