Skip to main content
diversification.com
← Back to S Definitions

Secured credit card

LINK_POOL:

What Is Secured Credit Card?

A secured credit card is a type of credit card backed by a cash deposit, which serves as collateral for the credit issuer. This makes them a part of consumer finance, specifically designed for individuals looking to establish or rebuild their credit history. Unlike traditional credit cards, the required security deposit mitigates the risk for the lender, making these cards more accessible to those with limited or poor credit. The credit limit on a secured credit card is often equal to the amount of the deposit, though some cards may offer a higher limit. Secured credit cards function similarly to unsecured cards for purchases and payments.

History and Origin

The concept of a secured credit card emerged in California in the 1970s, providing a pathway to credit for individuals who might otherwise be denied. These early versions typically required a deposit held in an interest-bearing savings or term account, such as a certificate of deposit. The available credit was often a percentage of this deposit, ranging from 50% to 80%. As the secured credit card market evolved, they became a crucial tool for credit building. For more than 40 years, secured credit cards have empowered borrowers with limited or damaged credit histories to access credit, often with similar benefits to traditional, unsecured credit cards. The Federal Reserve Bank of Philadelphia has explored the history and evolution of the secured credit card market, detailing its origins and current landscape.7, 8

Key Takeaways

  • A secured credit card requires a refundable cash deposit, which acts as collateral.
  • It is a tool primarily used to establish or improve a credit score and credit history.
  • The credit limit is typically set at or slightly above the amount of the security deposit.
  • Responsible use, including on-time payments, is reported to credit bureaus, aiding in credit building.
  • Many secured cards offer a "graduation" path to an unsecured card, where the deposit is returned.

Interpreting the Secured Credit Card

A secured credit card is interpreted as a stepping stone in personal finance, particularly for those with a limited or damaged credit history. Its primary utility lies in its ability to help consumers demonstrate responsible financial behavior. By using the card and making consistent, on-time payments, individuals can build a positive payment history that is reported to the major credit bureaus. This reported activity contributes to the calculation of their credit score, potentially leading to better terms on future credit products. The initial credit limit on a secured credit card is directly tied to the refundable security deposit, meaning cardholders are managing their own funds as a form of assurance for the issuer.

Hypothetical Example

Sarah, a recent college graduate with no prior credit history, wants to buy a car in the future and knows she needs to build her credit. She applies for a secured credit card that requires a $300 refundable deposit. Upon approval, her secured credit card is issued with a credit limit of $300.

Sarah uses the card for small, regular expenses like her streaming service subscription ($15 per month) and groceries ($50 per month). Each month, she makes sure to pay her full balance before the due date. After six months of consistent, on-time payments, her payment history is reported to the credit bureaus, and she sees her credit score begin to rise. Her responsible use of the secured credit card is helping her establish a positive credit profile.

Practical Applications

Secured credit cards serve as a vital tool in various financial scenarios. They are widely used by:

  • Individuals with no credit history: Young adults or new immigrants can use a secured credit card to establish their initial credit profile.
  • Those rebuilding damaged credit: After events such as bankruptcy or significant debt issues, a secured credit card offers a controlled environment to demonstrate renewed financial responsibility.
  • Consumers managing subprime credit: For individuals with low credit scores who might not qualify for unsecured credit, these cards provide a practical path to improve their creditworthiness.

Responsible use of a secured credit card is reported to the credit bureaus, which is crucial for building a strong credit score. The Consumer Financial Protection Bureau (CFPB) provides resources for understanding and choosing suitable credit card products, including secured options.6

Limitations and Criticisms

While beneficial for credit building, secured credit cards do have limitations. One common criticism is that they often come with higher annual percentage rate (APR)) and various fees compared to unsecured cards, such as annual fees or application fees, although some issuers now offer no-annual-fee options.3, 4, 5 The credit limit is typically low, usually matching the security deposit, which can restrict spending power and limit the potential for significant credit utilization rate benefits if balances are kept very low.

Another point of concern is that not all secured credit card issuers report to all three major credit bureaus, which is essential for maximizing the credit-building impact. Consumers should verify this reporting practice before applying. The Federal Trade Commission (FTC) has taken action against deceptive advertising claims by some marketers of secured cards, highlighting the importance of consumer vigilance when seeking these products.1, 2

Secured Credit Card vs. Debit Card

The main distinction between a secured credit card and a debit card lies in their function and impact on credit history. A secured credit card is a form of revolving credit, requiring a security deposit that acts as collateral for the credit limit. When you use a secured credit card, you are borrowing money up to your credit limit, and your payment history is reported to credit bureaus, helping to build or rebuild your credit score.

In contrast, a debit card draws funds directly from your linked bank account. It does not involve borrowing money, and therefore, its usage typically does not impact your credit history or credit score. While both cards offer a convenient way to make payments, only the secured credit card provides the mechanism for credit building.

FAQs

What is the purpose of a secured credit card?

The primary purpose of a secured credit card is to help individuals establish or improve their credit history and credit score. It allows people with limited or poor credit to access a credit line, provided they offer a refundable deposit as security.

How does the security deposit work?

The security deposit for a secured credit card is typically held by the issuing financial institution in a separate account and serves as collateral. This deposit protects the lender in case the cardholder defaults on their payments. It is usually equal to the credit limit and is returned to the cardholder when the account is closed, provided all balances are paid off.

Can a secured credit card help improve my credit score?

Yes, a secured credit card can significantly help improve your credit score if used responsibly. The card issuer reports your payment history to the major credit bureaus, and consistent on-time payments and low credit utilization rate will positively impact your score over time.

Are there any fees associated with secured credit cards?

Secured credit cards often come with fees, such as annual fees, application fees, or maintenance fees. It's important to research different cards and understand all associated costs before applying, as some options have fewer fees or a clearer path to graduating to an unsecured card.