A:

A secured credit card is a common, relatively safe strategy for those with little or poor credit to improve their credit score. Functionally, secured credit cards actually resemble a demand deposit account, like a checking account, more than a line of credit. Financial institutions or lenders may be unwilling to accept the risk of providing an unsecured credit card to a customer, so they instead offer a line of credit that has been secured with cash collateral. For example, you might be required to deposit $300 to open up a secured credit card.

A secured credit card is not the same as a prepaid debit card, where the cash collateral is placed into an account and drawn down by using the card. When you open a secured credit card, you are granted a line of credit with a zero balance and a predetermined credit limit. You are charged interest on the balance to your account. It may be that the credit limit is exactly equal to the cash collateral you had to put up to open the account, but this is not always the case.

If you are a member of a credit union, it is often best to look there for a secured credit card first. Credit union secured cards tend to have lower rates of interest and little or no monthly fees on the account. If you are shopping around for a secured credit card, do your research ahead of time and look for grace periods, low fees and lower rates of interest, and see if you are able to obtain a credit limit that is higher than your collateral deposit.

The main reason to get a secured credit card instead of a prepaid debit card is to build your credit score. Secured credit card payments and balances are reported to credit bureaus. No matter how much you spend on your prepaid debit card, you do not build your credit that way. In fact, the information reported on your secured credit card is treated the same as any other credit card. When you use a secured credit card responsibly, you can build your credit very quickly.

Regardless of the specific contract details of your secured credit card agreement, there are some rules of thumb to follow to help build your credit:

1. Do not max out your card. Not only do you incur higher interest charges on higher balances, but you hurt your credit utilization rate by borrowing too high a percentage of your limit. According to Experian, 35% of your credit score is determined by this rate.

2. Pay off your balance regularly. Consistent monthly repayment is viewed very favorably on your credit report, and you may even be able to avoid interest charges altogether if you make the most of any grace periods.

3. Use the card. Simply having a new credit limit does not help out your score much. Instead, buy a few things each month and make your payments. Manage your card responsibly and you may see an increased limit or even qualify for an unsecured card in the future.

Trading Center