In today’s modern financial system, it takes time, ingenuity and good spending habits to build credit. One of the recommendations you often see, after a cursory Google search for something like “credit building tips,” is to consider opening up a secured credit card account.
Before getting into the lowdown of this card type, we should say it certainly isn’t unwise to get a secured card, but there are pros and cons. Credit-strapped young professionals should know what factors play into both before making a decision on whether or not a secured card is the right choice for their financial future.
A secured credit card is largely similar to prepaid debit: Both are issued by traditional creditors and require an upfront investment by their users. By depositing funds from a non-credit bank account (or, in prepaid debit’s case, cash or check at your bank’s branch), you provide the financial institution collateral that eliminates or mitigates their risk. For instance, if you deposit $300 of your own money, you then have $300 in “credit” to spend on that card. There are exceptions, such as partially secured cards that require a deposit smaller than the credit line you’ll receive — but these aren’t the norm.
The primary difference between the two is that using a prepaid debit card doesn’t reveal anything to a creditor except that you had money you’re now spending through a different channel. On the other hand, timely repayments of balances from secured credit card purchases usually end up on your credit report and all major credit scoring models, theoretically proving your creditworthiness and raising your credit score.
Secured credit cards’ biggest perk is the opportunity to show good credit utilization and a knack for debt repayment, especially for younger consumers (in this era, Millennials and Gen Z) whose issue isn’t bad credit, but an overall lack of credit. Gerri Detweiler, director of consumer education for Credit.com, elaborated on this advantage:
“Someone who has no credit is likely to benefit more quickly from a secured card, because there’s no negative information — there’s just positive information, so in as little as six months someone who is just building credit can get an unsecured credit card,” Detweiler said.
Even if you have less-than-ideal credit, demonstrating that you’ve learned from past mistakes by using a secured card is still ultimately positive because of how much credit scores can affect your overall finances. You may consider using a secured credit card alongside a debit card in order to build credit, even if you don’t have an abundance of disposable income.
Secured cards typically have moderate-to-high interest rates and fees so creditors can further mitigate risk. This can make it more difficult to repay your bill if you can’t make a payment on time. Additionally, while a variety of account types is good for your score, secured and unsecured credit cards look the same to creditors.
Not all secured cards report to the Big Three credit bureaus. Make sure yours does when applying, or it won’t help you build your credit. This information should be somewhere in the card agreement. Last but not least, the main drawback to secured cards is the time it’ll take for them to have a major effect. If you’re having trouble with such a card, consider pursuing other sources of credit like alternative lending.