Here’s a catch-22: Getting a credit card is the quickest way to build good credit, but you often can’t get a credit card without good credit.
Secured credit cards can help people with bad credit or short credit histories escape this paradox. Here’s what you need to know about secured credit cards and how they differ from regular, or “unsecured,” cards.
A secured credit card is backed by a cash deposit you make when you open the account. The deposit is usually equal to your credit limit, so if you deposit $200, you’ll have a $200 limit.
The deposit reduces the credit card issuer’s risk: If you don’t pay your bill, the issuer can take the money from your deposit. That’s why these cards are available for people with bad credit or no credit.
What happens to that $200 deposit if you always pay your bill on time? You’ll eventually get it back. Use the card responsibly, and your lender may offer you an unsecured credit card — one that doesn’t require a deposit — after 12-18 months of building credit. When you upgrade or close a non-delinquent secured card, the issuer will refund your deposit — potentially with some interest, if you asked your lender to place it in a savings account or guaranteed investment certificate.
The minimum and maximum deposit amounts vary by card, but you should be prepared to come up with about 1-2 times the available credit limit.
Whether you need a secured credit card comes down to how good your credit is.
Unsecured cards don’t require a deposit and therefore pose more risk to the issuer, so credit-card companies typically require at least average credit for basic cards. They may require good or excellent credit for the best ones. Unsecured credit cards can also come with rewards or benefits, and do not require a set-up fee.
Some unsecured credit cards advertise themselves as easy to qualify for even if you have bad credit. But these cards often charge extremely high fees. NerdWallet recommends applying for a secured credit card rather than a high-fee unsecured card.
Once you’ve paid the initial deposit, secured cards work just like unsecured ones:
Most major credit card issuers offer both secured and unsecured cards. Set-up fees, typically a small percentage of your credit limit, are common, but you shouldn’t pay more than $50.
If you can’t qualify for an unsecured card, a secured card can be a great tool as you work to improve your credit. But it’s just as important to be responsible with a secured card as it is with any other loan or bill that shows up on your credit report.
Prepaid cards seem similar to secured credit cards. You have to pay money before you can use both types of cards, and both are typically issued by banks and have a Visa or Mastercard logo, or bought in stores.
But with prepaid cards, you’re using your own money to make purchases — not money borrowed from the issuer. You load money onto the card, and then the issuer uses that money to pay for your purchases.
Since these cards don’t extend any credit, your account activity isn’t reported to the credit bureaus. That means you’re not building a credit history by using a prepaid card. Prepaid cards do not charge the interest charges or fees that secured credit cards do. But you won’t earn interest or collect rewards with a prepaid card, either.
If building credit is your goal, a secured credit card is your best bet.
Although they require a deposit, secured credit cards are a powerful tool for building or rebuilding your credit. Here’s how to use one most effectively:
Many people find that carefully using a secured card for about a year helps improve their credit score enough that they’re able to qualify for an unsecured card. Some issuers will help you transition to an unsecured card, which is better for your credit score because it doesn’t require you to open a new account.
But even if you do have to apply for a new unsecured credit card, you may be able to enjoy some of the benefits of having good credit — lower interest, better rewards and more competitive fees.
When that day comes, the time you spent rebuilding your credit with a secured credit card will have been worth it.
Virginia is a former credit cards writer for NerdWallet. She is a journalist who has covered personal finance, business, real estate, architecture and design. Her work has appeared in the Philadelphia Inquirer, The New York Times, The Awl and Mental Floss.