Secured credit cards work like traditional credit cards but require a refundable security deposit as collateral. Here's a detailed explanation of how they work, including the security deposit, payments, and why they are less risky for lenders:
How Secured Credit Cards Work
- Security Deposit: When you apply for a secured credit card, you must provide a cash deposit, which typically equals your credit limit. For example, a $500 deposit usually gives you a $500 credit limit. The deposit acts as collateral for the card issuer, protecting them if you fail to pay your balance
- Using the Card: You use the secured credit card like any other credit card to make purchases up to your credit limit, both in stores and online. The deposit itself is not used to pay for purchases; instead, you are borrowing from the issuer up to your credit limit and must pay the balance back
- Payments: Each month, you receive a statement showing your balance, which you must pay at least the minimum amount due by the due date. Paying your balance in full avoids interest charges, while carrying a balance will incur interest like with unsecured cards. Your payment history is reported to the major credit bureaus, which can help build or improve your credit score if you pay responsibly
- Refund of Deposit: If you close your account in good standing or upgrade to an unsecured card, you can get your security deposit back. The issuer holds the deposit while you use the card, similar to a landlord holding a security deposit for an apartment
Why Secured Credit Cards Are Less Risky for Lenders
- The security deposit reduces the lender’s risk because it serves as collateral. If you default on payments, the issuer can use the deposit to cover the amount owed, minimizing their potential loss
- Because of this reduced risk, secured credit cards are often available to people with poor or limited credit histories who might not qualify for unsecured credit cards
- The deposit requirement incentivizes responsible use and timely payments, which helps lenders manage credit risk better than with unsecured cards.
In summary, secured credit cards require a cash deposit that sets your credit limit and acts as collateral. You make purchases and monthly payments like with any credit card, and your payment behavior is reported to credit bureaus to build credit. The deposit protects lenders from losses, making these cards less risky and accessible to those building or rebuilding credit
