Consumers have the option of applying for secured credit cards, unsecured credit cards, and debit cards. Getting approved for an unsecured credit card is contingent on the consumer having a good credit rating. Adverse credit history and poor credit scores will either act as a deterrent to approval or will force the aspiring card holder to contend with high interest rates (annual percentage rate APR) coupled with low credit limits, and high processing and annual fees. A person who does not have a bank account can get approved for a debit card without undergoing any credit checks. Convenience, however, comes at the price of high activation fees, ATM withdrawal fees, balance inquiry charges, and monthly maintenance costs. In fact, the card holder is also penalized for not using the card for more than 2 months at a stretch. Considering that debit card issuers, unlike credit card companies, do not report consumer activity to credit bureaus, one does not stand to gain much despite tackling a multitude of fees. Hence, secured credit cards for bad credit assume a great deal of significance.
Secured Credit Cards for Bad Credit
A number of positive features make secured credit cards an ideal choice for consumers looking to improve credit scores.
No Credit Check
The credit rating of the consumer is irrelevant when it comes to procuring a secured credit card. In fact, even people who do not have a credit history can get approved for a secured credit card, since the card is collateralized with an underlying savings or checking account deposit. The issuing bank also pays interest on the deposit.
The credit line is generally 50 to 100% of the amount of deposit. The consumer's credit limit, again, depends entirely on the amount that is deposited in the savings account (or checking) since it acts as the line of credit for the consumer. The card issuer may extend the credit limit if the card holder proves his/her creditworthiness by making regular on-time payments. This, in turn, reduces the credit utilization ratio, which is defined as the ratio between the total debt and the available credit. A lower credit utilization ratio is favorable and has the effect of increasing the credit score of the consumer.
The rate of interest that is charged on a secured credit card, is generally very high, since these cards are primarily sought by consumers with poor credit. People need to make monthly interest payments on the balance that accrues on the card. Generally, a grace period of 25 days is allowed, assuming that the consumer pays off the previous balance in full.
Secured credit cards can help people build their credit scores and establish their credit history, since consumer activity is reported to the credit bureaus. In other words, payment and default pertaining to the secured credit card, affect the credit report of the consumer. It is best if the consumer pays off the entire balance in full, instead of carrying over the card balance to the ensuing month. This is one of the ways of improving credit scores.
Converting Secured to Unsecured
People who make on-time payments and build a reputation of credit worthiness can hope that the secured credit card gets converted to an unsecured credit card within a span of 12 to 18 months from the date of issue.
As mentioned earlier, companies issuing secured credit cards for people with bad credit do not offer competitive interest rates. In addition to the high APR, the consumer has to pay a credit card processing fee (account set-up fee), an annual fee, and an application fee to avail the card. Some issuers may be willing to forgo the application fee. It's important to note that these charges are levied in addition to the required deposit, which acts as the collateral for the issuer. In addition to the aforementioned fees, credit card companies also charge balance transfer fees and overlimit fees.
If the consumer defaults on secured credit card payments, the underlying collateral, viz. the savings or the checking account deposit, goes towards repaying the dues. Defaulting on credit card payments has the impact of reducing credit scores. Hence, as far as possible, one should strive to repay the dues.
The biggest advantage of using secured credit cards for bad credit is that, the credit activity on the card is reported to the credit bureaus, thus, giving people an opportunity to rebuild or re-establish their creditworthiness. In addition to (bad credit) secured credit cards, payroll deduction cards may also be used by people who intend to build their credit scores.