If you have a low credit score or no credit history, you may have heard about secured credit cards as a way to build credit. But how do banks handle these types of accounts, and what should you know before applying for one? In this article, we’ll dive into the details of secured credit card accounts and how banks handle them.
What is a Secured Credit Card?
A secured credit card is a type of credit card that requires a monetary deposit as collateral. This deposit acts as security for the bank in case you are unable to make payments on your credit card. The amount of the deposit typically determines your credit limit, and you can use the card just like any other credit card.
Secured credit cards are often used by individuals with poor credit or no credit history to build credit. By making timely payments and keeping your balance low, you can improve your creditworthiness and eventually qualify for an unsecured credit card.
How Banks Handle Secured Credit Card Accounts
Banks handle secured credit card accounts in a similar way to unsecured credit cards, but with a few key differences.
Credit Checks
When you apply for a secured credit card, the bank will still perform a thorough credit check in order to assess your creditworthiness and assess the level of risk involved in granting you the card. However, due to the fact that you are providing a deposit as collateral, which acts as a safeguard for the bank against any potential default on your part, the bank may adopt a more lenient stance in terms of their approval criteria.
This leniency stems from the understanding that your deposit serves as a form of security and significantly mitigates the risk associated with extending credit to individuals with low credit scores. Consequently, even if you currently possess a low credit score, there is still a considerable chance that you may be approved for a secured credit card, thanks to the deposit you are willing to offer as collateral.
Credit Limits
As previously mentioned, it is important to note that the specific amount you choose to deposit will play a pivotal role in determining the credit limit you are assigned. Generally, the credit limit granted to you will either be exactly equal to the amount you choose to deposit, or it may even be marginally higher. To illustrate this point further, let us consider an example: if, for instance, you decide to provide a deposit amounting to $500, it is conceivable that your resulting credit limit could potentially range anywhere from $500 to $600, demonstrating how closely tied these two variables are.
Interest Rates and Fees
Secured credit cards often have higher interest rates and fees compared to unsecured credit cards. This is because they are considered higher risk for the bank. It’s important to carefully review the terms and conditions of a secured credit card before applying to understand the interest rates and fees associated with the card.
Reporting to Credit Bureaus
One of the main reasons individuals use secured credit cards is to build credit. To do this, the bank must report your payment history to credit bureaus. This means that your timely payments will be reflected on your credit report and can help improve your credit score over time.
Deposit Refunds
If you decide to close your secured credit card account, the bank will typically refund your deposit. However, this is not always the case. Some banks may hold onto your deposit for a certain period of time, or they may use it to pay off any outstanding balances on your card. It’s important to clarify the deposit refund policy with the bank before opening a secured credit card account.
Handling Defaults
Banks handle defaults on secured credit card accounts in a similar way to unsecured credit cards. If you are unable to make payments on your secured credit card, the bank may take several actions. First, they may use the cash deposit you provided as collateral to cover any outstanding balances on your card. If the deposit does not cover the full amount owed, the bank may report the delinquency to credit bureaus, which can negatively impact your credit score. Additionally, the bank may charge late fees and increase the interest rate on your card. In some cases, the bank may even take legal action to recover the debt. It’s important to make timely payments on your secured credit card to avoid these consequences and protect your creditworthiness.
How Secured Credit Cards Affect Your Credit Score?
As mentioned, secured credit cards can be a useful tool for building credit. But how exactly do they affect your credit score?
Credit Utilization
Credit utilization is the amount of credit you are using compared to your total credit limit. For example, if you have a credit limit of $1000 and a balance of $500, your credit utilization is 50%. A lower credit utilization is generally better for your credit score, and secured credit cards can help with this. Since your credit limit is determined by your deposit, it’s easier to keep your credit utilization low with a secured credit card.
Payment History
Payment history is the most significant factor in determining your credit score. By making timely payments on your secured credit card, you can improve your payment history and boost your credit score.
Credit Mix
Having a mix of different types of credit can also positively impact your credit score. By adding a secured credit card to your credit mix, you can show lenders that you can handle different types of credit responsibly.
Alternatives to Secured Credit Cards
While secured credit cards can be a useful tool for building credit, they are not the only option. Here are a few alternatives to consider.
Credit Builder Loans
Credit builder loans are a type of loan that is specifically designed to help individuals build credit. The loan amount is typically small, and the borrower makes monthly payments until the loan is paid off. The lender reports the payments to credit bureaus, helping to improve the borrower’s credit score.
Authorized User on a Credit Card
If you have a family member or friend with a good credit score, you may be able to become an authorized user on their credit card. This means that you can use the credit card, and the payment history will be reported on your credit report. However, it’s important to make sure that the primary cardholder is responsible with their credit card usage, as any negative activity can also impact your credit score.
One more thing before conclusion, iIt is important to know the disputing charges on secured cards.
In Conclusion
Secured credit cards can be a useful tool for building credit, but it’s important to understand how banks handle these types of accounts and what to consider when choosing one. By making timely payments and keeping your credit utilization low, you can improve your credit score and eventually qualify for an unsecured credit card. Consider all your options and choose the best one for your financial situation.
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