Do Secured Credit Cards Improve Credit?
If you have a poor credit history or no history at all, a secured credit card can help. Secured and unsecured credit cards generally are reported in the same manner on a credit report, and a card's status as secured or unsecured does not affect your credit score. Secured credit cards have the potential to improve your credit score, but it depends on how you use them.
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Secured vs. Unsecured
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Traditional credit cards are unsecured, meaning that you do not have to give the credit card company rights to seize a particular asset if you do not pay your bills. However, if you have no credit history or a bad credit history, credit card companies might not be willing to offer you a traditional unsecured credit card. In this situation, you can apply for a secured credit card. You will have to put down a cash deposit with the credit card company to obtain a secured credit card, and your credit line will be equal to the amount of the deposit. Deposit amounts can be as little as $200 to $300, depending on the credit card company. If you fail to pay your bills, the credit card company can use the deposit to recoup its losses.
Payment History
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The most important factor in determining your credit score is your payment history, which accounts for about 35 percent of your score. You can use a secured credit card to improve your credit score in this area by making your payments on time every month. Because your secured credit card is likely to have a lower credit limit than an unsecured card, this forces you to keep your balance low and keeps the minimum payment to a reasonable amount. As a result, you should be able to afford all your payments. However, if you do miss a payment, this will damage your credit score.
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Amounts Owed
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The second largest factor in your credit score is the amount you owe. With credit cards, the credit scoring formula also considers the ratio of your credit card balance each month to the credit card limit. This is called credit utilization, and a high credit utilization ratio (carrying a debt balance that is a high percentage of the credit limit) hurts your credit score. The balance is not just the amount you carry over from month to month, but also the total of the charges made during the month. Because secured credit cards have low credit limits, you must spend very little on the card to keep your credit utilization ratio low. The ratio should be kept under 30 percent, according to Liz Weston of MSN Money. Therefore, if your card has a limit of $300, keep your balance under $90 at all times for best results. If you max out the card, this could hurt your credit score.
Considerations
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Before applying for a secured credit card, ask whether the lender reports your account history to Experian, Equifax and TransUnion. If the lender does not, the card cannot affect your credit score. Also, be aware that applying for the card and opening the new account hurts your credit score a little in the short term, because your score considers your new credit and average account age. However, these effects will decrease over time.
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