If you have bad credit or are just starting out with credit for the first time, you may struggle to get approved for your first credit card or loan. You may find out along the way that it takes credit to build credit. That means you need some sort of credit account to establish your US credit score for the first time.
A secured credit card is one of the fastest ways to get started with credit and sometimes doesn’t require any prior credit for approval. It just takes a security deposit and an application to get up and running.
If you are asking yourself, “What is a security deposit for a credit card?”, our experts are here to help. Here’s a closer look at how the security deposit for secured credit cards works.
When you want to open up a credit card with no credit or a bad credit score, most traditional lenders at a financial institution will be very hesitant to open a new account with you. While you may fully intend to pay off your credit card balance in full every month, which is a great credit habit, if a lender doesn't know you personally, all they have is your credit history to go off of.
If you don’t have a good credit history, lenders may see that you have missed payments in the past, which can mean you’re a greater risk to lend money to. Or perhaps you have no credit history, so they have nothing to base a decision on.
In this case, you may not qualify for an unsecured credit card.
With secured credit cards, Instead of just relying on your credit like you do for an unsecured credit card, lenders use a refundable security deposit to make sure they don't lose out when lending you money.
Unlike an unsecured card, secured credit cards require a deposit equal to the credit limit. For example, if you want a $500 credit limit, you would need to put down a $500 deposit for the card issuer. For a $1,000 limit, you would need a $1,000 deposit.
This deposit is a guarantee that the secured credit card issuer won't lose money when giving someone a new security deposit credit card.
It works a lot like a security deposit for utilities. As long as you make each monthly payment on time and have an account in good standing, you can get the deposit back if you ever decide to close the account.
Most secured credit cards give you the full deposit back when you close your credit card account with a $0 balance at some point in the future.
But you won’t want to rush and close your account right away. The longer you have it open, the more it helps your credit, since it increases the average length of your credit history, which is a major factor in your credit score.
A secured credit card is designed to help you build credit and motivate you to keep good credit habits. S
If you pay off your balance in full each month by the due date, you’ll never have to pay any interest. At the minimum, you should pay at least the minimum payment by the due date each month. This helps you build credit and stay on track to getting your deposit back while also maintaining a healthy payment history.
Once you have the card for a year or two, assuming you paid on time every month, you should have established at least a good credit score. If you had bad credit, on-time payments can put you on the way to credit recovery.
If you have a credit card balance and don’t pay it back, the lender may keep a portion to get paid back for what you borrowed. If you pay it off in full, you will get your full deposit back when you close your account.
An excellent credit score can help you get approved for the best rewards credit cards or low-interest cards with no security deposit in future. It can also help you get approved for a mortgage at the best interest rates, an auto loan, and more. The benefits of a good credit score can easily save you tens of thousands of dollars on a mortgage.
While some lenders have a minimum credit score required to open a secured card, not all do. With a deposit ready, you can open a secured card and start building or rebuilding your credit right away.
If you follow good habits with your secured credit card, you’ll get the full deposit back when you close your account in the future, ideally with a good credit score, or better.
Eric Rosenberg is a former bank manager and corporate finance worker with a Bachelor’s degree and MBA in finance. His work is featured at Business Insider, Credit Karma, The Balance, Investopedia, and many other websites and publications. See Eric on Linkedin and Twitter.