It’s an annoying catch-22 for those starting out: most creditors want to see a good credit history before they’ll issue you a credit card, yet one of the main ways to build a credit history is to use credit cards responsibly. Some credit newbies build their credit history by piggybacking on a parent or spouse’s credit card as an authorized user.
For those who don’t have that option, secured credit cards, where you pay a deposit as collateral, offer an alternative. With a secured card, creditors limit their risk by only extending as much credit as would be covered by your deposit in case you default. “Typically there’s no cash back or travel rewards or points you can earn on a secured card,” says Howard Dvorkin, CPA and founder of Consolidated Credit Counseling. “It’s a bare bones credit product.”
Still, secured cards might make sense for those with poor credit or those starting out, such as college students. “In the year 2013, you need some source where you can charge a hotel, charge an airline, or rent a car,”Dvorkin says. “This is one way you can pretty much guarantee yourself access to credit.”
The typical deposit starts as low as $200 and can go as high as $2,500, he adds. Some creditors pay interest on your deposit but with interest rates so low, the amount is often negligible. Some secured cards also carry hefty fees so make sure you understand the product before signing up.
“Sometimes I’ve seen it where they charge you $250 just to open a secured card,” says Dvorkin. “There [can be] penalties if you’re late. Watch out for the interest rate, say, if you carry a balance. What is the interest rate you’re charged before they take your deposit? Not all secured cards are created equal.”
Also make sure you’re dealing with a card issuer that reports on-time payments to the credit bureaus so you can build your credit history and eventually work your way up to an unsecured credit card with fewer fees and a higher limit. Ideally, your payments should not be reported as a secured card because that can signal potential problems in your past, according to Dvorkin.
Some issuers of secured credit cards will eventually graduate you to an unsecured credit card, which is the ultimate goal for most people. This depends on the individual and the creditor, but Dvorkin says it can happen after six to twelve months of on-time payments.