According to a study by the Consumer Financial Protection Bureau, 45 million consumers in the United States have either little or no credit history. If you are in this position, it would be very beneficial to start establishing a credit profile. But it’s a catch-22: it’s tough to establish credit when you have little or no credit history.
That is where a secured credit card can be extremely beneficial. And recent research by the Green Dot Corporation shows that responsible use of a secured credit card can pay rather quick dividends in building your credit score.
Green Dot analyzed their very extensive base of secured credit card customers and their activities during 2017 and 2018. They took a look at consumer payments and what effect on-time payments had on the customer’s FICO score.
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“Our research found that FICO scores went up by approximately 20 points after making five on-time payments, and an average of 70 points after 12 consecutive on-time payments,” said Jordan Morse, Senior Brand Director for Green Dot Corporation.
Consumers who are finding it difficult to establish credit may want to consider obtaining a secured credit card and making at least the minimum payment on time every month.
There is some consumer confusion on what exactly a secured credit card is and how it may differ from a standard credit card. Let’s try to clear up any misconceptions.
How Secured Cards Work
A secured credit card is actually very similar to an unsecured card with one major difference. People who apply for a secured card typically have either very little credit history or have had some financial difficulties in the past. This makes them more of a risk for the card issuers to approve. In order to minimize that risk, issuers require the applicant of a secured card to put down a refundable security deposit. Once you are approved for the secured card, this deposit will usually serve as your credit limit.
From that point forward, your secured card will look and work just like a standard credit card account. Merchants or friends will never know it is a secured card. A secured cardholder can make charges anywhere. You receive a monthly statement of your transactions, and you must make at least the minimum payment prior to the due date. If you do carry a balance, interest penalties will be assessed to your account. As with any credit card, you can avoid all interest if you pay the entire balance in full and on time by the due date.
If you ever close your secured card account, you will receive your initial deposit back in full as long as your entire balance has been paid.
Building Credit with a Secured Card
A majority of secured credit cards report to the three major credit bureaus. If you use the secured card responsibly, it can help you slowly build your credit score. Responsible use of a card includes paying at least the minimum payment by the due date every single month, and keeping within the credit limits established by your issuer, usually your security deposit.
Tips for Using a Secured Card to Improve Your Credit
1. Make every monthly payment on-time. The most important factor in your credit score is your payment history. Late payments on any bill can damage your score, so make every payment on time, well ahead of the due date. Issuers usually provide tools to help you in this quest. Many offer text or email alerts that can be set up, reminding you of your payment due date. Another option is to set up automatic monthly payments from your checking account. Whatever you do, make the payments on time.
2. Keep your debt level low. A second critical element of your credit score is how much debt you are carrying. If your issuer reports to the three major credit bureaus, your activity will be recorded each month. You want to keep your balance as low as possible. In fact, it is best to use less than 30% of your available credit. To understand this, take a look at your credit limit. If you have a $1,000 credit limit on your account, you should not carry a balance of greater than $300. Anything higher than this 30% benchmark may signal to the issuer that you are experiencing some financial pressure.
3. Avoid needless interest charges and fees. You will incur very expensive interest penalties if you carry a balance from one month to the next. When you do not pay off your entire balance by the due date, you are really taking out a short-term loan from the credit card issuer, and for that, you will likely pay a very high interest rate called the APR. Paying off your entire balance will eliminate these penalties. Likewise, never take out a cash advance on your credit card. The interest rates on cash advances are usually even higher than the normal APR.
4. Keep an eye on your credit score. A significant number of credit card issuers now give their cardholders free access each month to their credit score. This score is your financial report card that all financial institutions review when they are deciding whether to do business with you. Monitor your credit score. With on-time payments, you may begin to see it increase which can give you some necessary encouragement. If your score unexpectedly takes a dip, investigate the cause of the drop and correct it. Maintaining a good credit score will be one of the smartest financial moves you make.
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