What Are Secured Credit Cards? How Do They Work?

September 18, 2021 Mutual Fund

A few days back, I received a call from my friend who complained about how his credit score dropped because a couple of his car loan EMIs bounced in the last quarter. Well, it was not wholly his fault since the bank had mistakenly linked his secondary account to the loan account for auto-payment of the EMIs, which did not have sufficient balance. However, this slight negligence cost him his credit score!

Since he is planning to avail of a home loan in the near future, he needed to improve his credit score as soon as possible. His financial planner advised him to opt for a credit card and make timely payments, which would help him improve his credit score faster. But is it really possible to get a credit card with an average credit score? If you are looking for a one-word answer – Yes. It is possible to get a secured credit card even with an average credit score.

Read on to know what secured credit cards are and how do they work.

What is a Secured Credit Card?

Almost all the leading banks have started issuing secured credit cards. This type of card is issued against collateral. This means, the banks usually ask for a cash deposit, popularly known as fixed deposit, and provide you with a credit card against 80%-85% of the fixed deposit amount. That said, if you make a fixed deposit of Rs 5,00,000, you will have a credit card limit of approximately Rs 4,00,000. Some banks offer a credit limit of 100% of the fixed deposit amount. However, banks generally have minimum and maximum credit limits, which vary from card to card.

The bank does not hold any risk by issuing a secured credit card, since a fixed deposit backs the card. Your bank puts a lien on the fixed deposit linked to the credit card, which ensures no one can withdraw the money in the fixed deposit unless the bank removes the lien. So, in case you default on the credit card payment, the bank can recover the money from your fixed deposit.

What are the Features and Benefits of a Secured Credit Card?

• Backed by collateral:

  A secured credit card is backed up by a fixed deposit that acts as collateral, securing the credit card provider in case the card holder defaults the payment.

• Wide acceptance:

  Like any other unsecured credit card, this card is accepted at most online as well as brick and mortar stores. The seller does not need to know that your card is not a regular unsecured credit card since it works just like a standard credit card.

• Fewer benefits:

  Although you can use the secured credit card anywhere, it might not offer the same rewards as a regular credit card. This is because the benefits offered on credit cards differ from card to card and are mostly depend on the creditworthiness of the card owner.

• Lower fees and charges:

  Secured credit cards generally have lower yearly fees and rates of interest compared to regular credit cards. This is because the credit card issuer does not hold any risk in case the credit card issuer defaults the payment.

• Helps improve your credit score:

  Using your credit card responsibly and timely payments of your dues will gradually increase your credit score, making you eligible for unsecured credit cards and loans.

For whom are secured credit cards ideal?

While anyone can opt for a secured credit card, opting for one even when you are eligible for an unsecured credit card does not make any sense. Here are the set of people for whom secured credit cards are ideal:

1. Average credit score:

   A credit card is the best way to improve your credit score fast. However, if you have an average credit score, your loan or credit card applications will not get approved easily. In such a case, it is advisable to apply for a credit card backed by a security deposit, which will help you improve your credit score when you make timely payments of the credit card dues.

2. No credit history:

   The credit bureaus give you a rating of 0 to -1 if you do not have a credit history at all or if it is less than six months. The lenders consider your profile as risky if you do not have any credit history, especially for bigger loans, such as a home loan and car loan, or a personal loan that does not require any collateral. Therefore, secured credit cards can help you build a credit score to prove your creditworthiness.

3. No income source:

   A credit card is offered only to those individuals with a proven income source and who meet the minimum income criteria. However, there can be instances when you require a credit card, even though you are not eligible for one. Therefore, if you are a retired senior citizen, housewife, or someone who is not eligible for a regular credit card for any income-related reason, a secured credit card is ideal for you.

How to improve your credit score or build a credit history with a Secured Credit Card?

Since the primary purpose for most people to opt for a secured credit card is to build a strong credit history or improve their credit score, it is vital to know how you can you achieve it with a secured credit card:

• Make sure you do not require the money you have deposited as collateral to avail a secured credit card for the long term. Since the bank puts a lien on a fixed deposit, it is impossible to get the money back unless you close your credit card account.

• It is necessary to pay attention to how much of the available credit limit you utilise. Using only up to 20% of your available credit limit is advisable since the higher Credit Utilisation Ratio (CUR) can negatively impact your credit score.

• Make small transactions with your secured credit card every month and remember to pay the bills in full before the due date. Paying the Minimum Amount Due will not only unnecessarily increase your expenses with a higher rate of interest, but also harms your credit score.

• Keep track of your credit score. Multiple credit score inquiries can also have a negative impact on your credit score. So you may check it once or twice a year. And, if your credit score has improved, you may apply for a new unsecured credit card.

How to close your secured credit card?

Once you have achieved a good credit score and built up a more robust credit history, there is no point in retaining the secured credit card, since you will be qualified for unsecured credit cards that offer higher credit limit and many more benefits. Make sure you close your credit card account properly, as not doing so may harm your credit score.

The following steps explain how to close your secured credit card account properly:

1. Make sure your unsecured credit card application is approved before proceeding to close your existing credit card account.

2. You may inform your credit card issuer by visiting the nearest branch or simply calling the customer care number mentioned on the back of your credit card.

3. Most banks insist on submitting a written request or a credit card closure form duly signed by the credit card holder along with a physical credit card.

4. You will receive intimation once the credit card is closed.

5. Bank removes the lien from your security deposit. If you wish, you may continue the fixed deposit with the bank or close the fixed deposit account and get the money back.

Secured credit card v/s prepaid credit card:

Secured credit cards are somewhat similar to prepaid credit cards. However, the critical difference is that a prepaid credit card cannot build a credit history.

Unlike secured credit cards, a cardholder has to load the required amount of money into the card, which they can use to transact with the prepaid credit card. So, the cardholder does not have credit card bills to pay because the money they spend is loaded in advance. Technically, the cardholder does not take any credit from the prepaid credit card issuer since they use their own money. Therefore, there are no eligibility criteria of a minimum credit score; neither can the prepaid credit card help you build a credit history or improve your credit score.

To conclude:

Since secured credit cards offer fewer benefits and rewards, it is advisable to opt for them only if you do not have a good credit score to qualify for an unsecured credit card. Make sure you understand the product features before taking a plunge, as each bank offers slightly different features and benefits. Please keep in mind that building your credit history and improving your credit score will not happen overnight. Depending on your current credit records, it might take one year to two years to see the positive impact on your credit score. Additionally, ensure you responsibly use the credit card and make timely payments to improve your credit score faster. Finally, you have to be patient and work towards achieving your goal until you see the desired result. An excellent credit score is worth the wait!

This article first appeared on PersonalFN here