Those who have bad credit — or no credit — may be paying a high price for borrowing: high-interest rates on credit lines, rejection on new loans and maybe even trouble securing an apartment lease.
The simple answer is to establish a good credit score, but accomplishing that is often not so simple. A secured credit card can help.
What makes a secured credit card different from traditional credit cards? "It's a credit card where people are securing their credit lines with collateral, in which case it would be a cash deposit," said Barbara O'Neill, personal finance professor at Rutgers Cooperative Extension. "Basically, you are funding your own credit line."
Secured cards are particularly well suited for those with bad credit or no credit history — people who are starting from scratch or starting over. It's also an alternative for those withoutanother adult to act as a co-signer on a new card.
The credit line on a secured credit card is usually for the same amount of your deposit, though it can be higher. For example, if you give the lender a $300 deposit, you will get a $300 credit line. If you default, the lender keeps your deposit. Otherwise, your deposit gets returned when you close the card.
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"The deposit reduces the lender's risk," O'Neill said.
It's similar to using a prepaid card or debit card in some ways, but there is an important difference. With a secured credit card, your credit behavior will be reported to the three main credit bureaus: Experian, Equifax and TransUnion.
"If you're interested in building your credit, you need to prove your credit worthiness," said Sean McQuay, a credit card associate at NerdWallet. A secured credit card is a simple way to do that, he added.
Before getting one of these cards, McQuays said, consumers must be "confident that they can be financially trustworthy. With any type of credit it's important that you're in a position that you can pay off the balance in full every month."
Experts also advise shopping around, compare different secured credit cards for interest rates and fees, and read the fine print before applying for one.
Compare at least three credit cards, compare all the features and decide which one is best, O'Neill said.
Experts recommend looking out for security deposit minimum requirements, which usually range between $200-$500; annual percent rates and for any fees, including application, processing or yearly fees.
When Eduardo Flores was ready to buy his first car last year at age 19, he couldn't get a loan because he didn't have any credit history. He also wanted to get out of his parents' cellphone plan and get his own, but even though he was approved, he was asked to pay a $500 deposit.
"It was pretty frustrating. I thought that having no credit would be better than bad credit, but it wasn't," the college sophomore from Texas said.
After about 15 rejected inquiries, Flores began researching how to establish a credit history and came across secured credit cards. He applied to Capital One's secured credit card and was approved. He put down a $100 deposit and got a $200 credit line.
It has been almost two years since Flores got a secured credit card. He now has a credit score of 680 and was recently approved for a $16,000 loan to buy his first car — a 2016 Chevrolet Sonic.
"I've established enough credit to get my own car without a co-signer," he said. "To this day, it still seems too good to be true, but I definitely feel building credit is something to be proud of and it motivates me to learn more about it and become better at it as I see results."
Flores said he will keep the secured credit card for another four to six months to boost his credit score before he transitions to a standard credit card.
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One benefit of making the switch: Secured credit cards tend to have higher APRs than traditional credit cards and don't offer rewards.
"Consumers should only have them for a year to 18 months, and then they should be graduating to standard credit card products," McQuay said.
Depending on the bank, you may be able to transition from secured to an unsecured card within the same account, otherwise you will have to close the card, which would impact your credit score, and open a new account, McQuay said.
"Think of it as a minor inconvenience," he said. "It's not a deal breaker."
Once they have, of course, it's even more important that they monitor their credit and make sure they don't use more than they can pay off quickly (ideally, that month) so they can keep their good credit intact.