Secured debt is debt that you back up with collateral. In the case of a secured credit card, that collateral is cash. Your upfront cash deposit dictates the credit line for the account and if you don't make your payments, the bank keeps your cash.
Unsecured debt, like a typical credit card, has no such collateral, and therefore presents a far greater risk to lenders. The credit score system serves as a way to reduce that risk to lenders by assessing your reliability. After all, if you've paid your bills on time and in full in the past, you're likely to continue doing so in the future. Unfortunately, the good credit history necessary to qualify for credit, takes credit in the first place- talk about your Catch-22.
That's where secured credit cards can prove handy. In establishing new credit, repairing past credit, and setting limits on consumer spending, secured credit cards can serve as useful financial tools for many consumers- especially these three groups…
New Credit Users
As a new credit user with no credit history, you'll probably have trouble being approved for a traditional unsecured credit card. A secured credit card can offer a useful alternative; providing you with the perks and leverage of a credit card while helping you build your credit history for the future. Once you've proven yourself a good candidate for unsecured credit with responsible use of your secure credit card, you can start applying for other lines of credit.
Those With Poor Credit History
If you want to repair or re-establish your credit after a major credit faux pas, or a long history of poor credit management, a secured credit card can give you that opportunity. Choose a secured credit card with a minimum deposit you can reasonably afford so that you don't stretch yourself too thin, risking a future missed payment, which could hurt your credit even further. After establishing a new, responsible credit history, you can increase your credit line, helping your credit score, and maybe eventually, switch back to an unsecured card.
Those Who Spend More than They Can Afford
Credit can be dangerous for those who have a tendency to overspend. Using a secured credit card can give frequent overspenders a chance to build (or rebuild) credit while setting very clear limits on what can be charged. Unfortunately, secured credit cards generally come with annual fees and higher interest rates than their regular, unsecured counterparts. Once secured credit card holders learn to use their card responsibly, they should consider transitioning.
By demonstrating responsible consumer behavior- making consistent, on-time payments- all three types of consumers should be able to improve their credit scores in due time and qualify for an unsecured credit card and other forms of unsecured debt. In the meantime, the secured credit card can prove a valuable tool.
Learn what to consider when choosing a secured credit card and which cards come recommended in Money Saving Pros Best Secured Credit Card Review.