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If you're looking to build or rebuild credit, there are a number of credit cards on the market that are designed for that purpose. Secured cards are one of the best options for credit newbies or people with less than stellar credit.
You can use a secured card just like a traditional (aka unsecured) credit card to help you establish good credit, as long as you practice responsible credit behavior.
A secured card is nearly identical to an unsecured card in that you receive a credit limit, can incur interest charges and may even earn rewards. The main difference is you're required to make a deposit (known as a security deposit) in order to receive a line of credit. The amount you deposit usually becomes your credit limit.
Deposits typically start at $200 and can range to upwards of $2,500. If you make a $200 security deposit, you'll receive a $200 credit limit. If you want a bigger credit limit, you'll need to deposit more money.
The amount you deposit acts as collateral if you default on payments, but it's completely refundable in one of two ways: Pay off your balance in full and close your account, or upgrade to an unsecured card.
Secured cards offer many of the same benefits as traditional credit cards, but they are typically easier to qualify for if your credit history is poor or non-existent.
The one big difference, in addition to the required security deposit, is the interest rate. Secured cards usually offer all users one variable interest rate, say 24.99%, for example. Meanwhile, an unsecured card often features a range, say 13.99% to 24.99%. In most cases, the better your credit score the lower APR you'll receive. Since secured cards often only have one, relatively high APR, it's extremely important you always pay on time and in full to avoid interest charges.
When you responsibly use a secured card, making payments on time and in full, this information will be sent to the three main credit bureaus, Experian, Equifax and TransUnion, which helps boost your credit score and puts you on the path to qualifying for an unsecured card.
Payment history is the most important factor of your credit score, making it key to always pay on time. If you consistently make on-time payments with your secured card, positive information will be reported to the credit bureaus, which helps you build credit.
There are a few things to consider when choosing a secured credit card: how much is the required deposit, how do you transition to an unsecured card (more on that below) and can you earn rewards?
One strong secured card option is the Discover it® Secured, which requires a $200 deposit but comes with some good perks. You can earn rewards (2% cash back at gas stations and restaurants, on up to $1,000 in combined purchases each quarter, then 1%, and unlimited 1% cash back on all other purchases), there's no foreign transaction fees and there's no annual fee.
If you're looking for a card that requires a smaller deposit, you might want to consider the Capital One® Secured Mastercard®. If you qualify for the low $49 or $99 deposits, you'll still receive a $200 credit limit.
While a secured card is a great way to build credit, it's not an ideal long-term option since you have to deposit money to receive a credit limit. Eventually, you'll need an unsecured card that provides a bigger credit limit without a deposit.
The transition from secured card to unsecured card varies by card issuer. Some card issuers may perform periodic account reviews to evaluate whether you can be switched to an unsecured card. For the Discover it® Secured, Discover will review your account starting at eight months from account opening to see if you can get your security deposit back and upgrade to an unsecured card.
If your card issuer doesn't offer an automatic upgrade process, you can simply call the number on the back of your card and ask to be transitioned to an unsecured card. They may transition you to a similar card that doesn't require a security deposit. Be aware that a credit check may be performed.
Some card issuers may not offer a transition process, so that means you'll have to apply for an unsecured card and close your secured card account. Experts generally don't recommend closing credit cards, but secured cards are a bit different since you're required to put up collateral.
Before you close a secured card, make sure you apply for a new card and are approved. If you close your card before opening a new one, it may be more difficult to be approved.
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Information about the Discover cards and Capital One® Secured has been collected independently by CNBC and has not been reviewed or provided by the issuer of the card prior to publication.