In the credit card world, secured cards are often viewed as second-rate. And often that’s due to common myths about how they work. In fact, you may be surprised at how a card like this can help you.
Myth: Secured cards are looked down on by other creditors.
There’s a misconception that if one of these cards is flagged as a “secured card” on credit reports, it’s somehow a scarlet letter that signals a borrower isn’t creditworthy. But that’s just a myth, says Barry Paperno, Credit.com’s Community Director and a credit scoring expert. “Regardless of whether they say ‘secured’ or not on the tradeline, the score will treat it the same — no difference,” he insists. “That description has no bearing on the score. Period.”
When it comes to a secured card and your credit history, the two things you want to focus on are payment history (more on that in a moment) and utilization. Because a secured card often has a small credit limit that’s equal to the deposit, it’s easy to max out the card, which can hurt your “utilization ratio” and your scores. To be on the safe side, strive to keep your balance at any given time at 10% – 25% or so of your available credit.
And if your goal is to build or rebuild credit with a secured card as a reference, be sure the card issuer will report your positive payment history to all three major reporting agencies each month. (Also, as you try to build credit, you can keep an eye on your credit score using a service like Credit.com’s Credit Report Card, which lets you check your score for free once a month.)
Myth: Secured cards and prepaid cards are the same.
A prepaid card allows you to load money onto the card, then spend that money, and repeat. With a secured card, you do place funds with the issuer as a security deposit, but you won’t continually draw upon and reload those funds. Instead, the deposit is there as collateral in case you default.
Prepaid cards are debit cards and they aren’t reported on standard consumer credit reports. (Not even Suze Orman has been able to change that.) But as long as a secured card issuer reports payment activity to the bureaus, one of these cards can provide a valuable credit reference on your reports.
One more key difference between prepaid cards and secured cards: only secured cards are covered by the Fair Credit Billing Act, which provides strong rights in the case of fraud and billing problems.
Myth: I don’t have to make payments because they have my deposit.
Depending on the card issuer’s policies, if you fail to make at least your minimum payment on time, your account may be considered delinquent, and you may be charged a late fee. That can happen even if your security deposit more than covers your monthly payments.
Read the card issuer’s terms and conditions before you sign up for the secured card, and then read the cardholder agreement when you get the card to find out how payments are handled. No, it’s not especially fun reading, but wouldn’t you rather know upfront how it works and avoid problems down the road?
Myth: Secured cards are only for people with bad credit.
While secured cards are a popular way to get a credit card after bankruptcy or other credit difficulties, there are myriad reasons why someone might get one of these cards. Perhaps you’re a young person or immigrant trying to get your first credit card. Or maybe you’ve paid off a lot of credit card debt and don’t want the temptation of a traditional card. Perhaps you try to follow Dave Ramsey’s advice to live debt-free, but you still want a credit card as a credit reference on your reports.
Whatever the situation, don’t be embarrassed to try a secured card. It looks just like any other card and can be used anywhere that brand of card is accepted.
Myth: Once secured, always secured.
If your goal is to get a traditional unsecured card, this may be your first step in that direction. If your credit gets stronger, you get offers in the mail. Or you may be able to successfully shop around for a different card. In the meantime, you will have a card you can use for online or everyday purchases and you don’t need to worry about running up balances you can’t pay back right away.
Image: Shawn Rossi, via Flickr