Rebuilding Credit: Pros and Cons of Secured Credit Cards

Secured credit cards are one way of leveraging your assets and rebuilding your credit. A secured card requires collateral; if you default on the credit line, the lender will seize your collateral. Using a secured credit card can be a useful strategy for those with low credit scores because lenders are more likely to issue loans to high-risk borrowers if there is collateral on the line. The risk of the loan is almost wholly transferred to the borrower in this case, however, which presents a potentially unfavorable situation. 

How Secured Cards Rebuild Credit

Your credit report takes into account a number of factors in determining your score. First, your debt history is recorded. Your record of repaying loans will be a large factor. When you take a secured card and begin repaying debts on time, you can help this factor. Beyond simple payment records, your credit score reflects your available credit compared to your current debt. By increasing your credit limit, you can make this measure more favorable. 

Benefits of Secured Cards

When you suffer from a low credit score, your ability to secure a credit card may be compromised. Many lenders will simply reject your credit card application. Others may approve your application but issue very low limits or high financing fees. All of these can be roadblocks to prevent you from rebuilding credit. By offering up an asset as collateral, you partly or wholly remove any risk from the lender's side of the agreement. This makes it possible to get a credit card despite your bad credit. Nearly any collateral can be used, including stocks, cars, home equity or even a savings account.

Drawbacks of Secured Cards

The main drawback of a secured credit card is the risk associated with the debt. If you are late on payments, you will see a near immediate action from the lender threatening your collateral. You should never risk collateral you could not live without for this reason. You should also assure that you have at least three months' payment saved in case of an emergency. A further drawback of a secured card is the fact that it does not boost your credit as much as an unsecured card. When you place an asset down as collateral on a loan, it is no longer considered an asset on your balance sheet. You have surrendered ownership temporarily. Because secured cards lower your available assets, there is a negative credit consequence that partly counters any positive credit report. 

Alternatives to Secured Cards

If you would like to rebuild your credit without a secured credit card, consider starting with low-limit secured installment loans. For example, purchase a small appliance on credit. Repay the lender in regular installments over a short period. Many small installment loans can be offered at zero interest within a short window. For example, computer loans and camera loans are commonly extended in this manner. Since these loans are repaid very rapidly and interest does not compound, they are inexpensive methods for building credit quickly. 

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