Credit Cards

What Are Secured Credit Cards and How Do They Work?

secured credit cardAccess to credit is just one of the markers in the seemingly widening gap between rich and poor, just another way in which “the rich get richer”. When you have a good credit history, it is easier to make more purchases on credit, further improving your credit card history, and eventually even qualifying for big loans such as car loans, home mortgages, and even small business loans. The flip side is that, when you do not have access to credit, you are more vulnerable to charges that people with established credit do not have to pay. One famous example is that, if you have to cash your paycheck and do not have a bank account, you have to pay considerable fees. Whether you call this a poverty tax or a poverty surcharge, it is frustrating that, in the words of comedy writer John Cheese, “you get charged for using your own money”. You may despair of finding a credit card for bad credit, but secured credit cards can be a good first step to building your credit.

What Is Unsecured Credit?

Access to credit is based, ultimately, on reputation. In the documentary Lambert and Stamp, Pete Townshend of the band The Who tells the story of how, when his band was just starting out, he met music producer Kit Lambert, whose father was a wealthy, famous musician. Lambert brought Townshend to his favorite wine shop and told him to choose what he wanted and to ask the cashier to start a tab for him. Townshend was able to buy thousands of dollars’ worth of wine on credit, simply because he was a friend of Kit Lambert, although if the store owner had asked him to pay for it immediately, he would not have had enough money. Later, when the band became successful, Townshend returned to the wine shop and offered to settle his bill, but the store staff refused.

The story of Pete Townshend and the wine shop is an extreme example of unsecured credit, but it illustrates the principle nicely. When you have an unsecured credit card, you have a credit limit, say, $1,000. This means that you can make up to $1,000 of purchases based simply on the promise that you will pay. (Of course, you are required to pay minimum payments, and there are interest charges, but these are much more manageable than having to come up with the money for a big purchase all at once.) The way you get approved for an unsecured credit card is through your credit history, and the better your credit history, the higher your credit limit. “Credit history” is just another name for your reputation for earning a steady income and making recurring payments on time. Once you have built a strong credit history, it is easy to get an unsecured credit card. For bad credit, however, secured credit cards can be your best option.

What Are Unsecured Credit Cards

To get an unsecured credit card, all you have to do is show your credit history. You do not actually have to pay anything to get the card. A secured credit card, however, requires you to pay a certain amount of money as collateral before you can have access to the credit. The money you paid as collateral usually gets returned to you a few months after you close the account, much the way a security deposit is returned to your after you move out of an apartment at the end of your lease. In most cases, the amount of collateral you deposit is equal to the credit limit on your secured credit card, at least when you first get the secured credit card. Some lenders will increase the limit of your secured credit card beyond the amount of the collateral you deposited after you have been consistent for a few months in paying off the balance on your secured credit card.

How Secured Credit Cards Can Help Your Credit

Given the choice between a secured credit card and an unsecured credit card, almost everyone would choose the unsecured credit card. A secured credit card, however, might be your only choice of credit card for bad credit. Secured credit cards require a deposit of collateral, and some of them have high interest rates, but dealing with these expenses is better than just spending your money without building your credit history. Using a secured credit card successfully, that is, paying off its balance every month and especially not missing payment deadlines, can make it a lot easier to help you qualify for an unsecured credit card. Many secured credit card users begin receiving offers for unsecured credit cards within a year.

 

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