Helping Young People Build Credit with Secured Credit Cards

November 5, 2019  |  

Helping Young People Build Credit with Secured Credit Cards

Now is the time of year that we all give our credit cards a workout. Most of us are responsible with our cards. We pay them off aggressively, if not entirely in full each month. We’ve been around the block enough times to know that compound interest is your friend as a saver, but your bitter enemy as a debt holder. We also know you need to keep your credit history in good standing to give you the best possible rates when it comes to obtaining a significant “sweaty palms” loan such as a mortgage or a car loan.

But, the teens and 20-somethings in your life don’t always see debt management that way. They tend to purchase what they want, whenever they want to, and don’t lose a lot of sleep knowing they’ll have to settle their tab eventually with the bank granting them use of their credit cards. Young people often feel they’re indestructible whether it’s partying all night, exercising vigorously or participating in high-risk action sports. Sadly, the same goes for their personal finances.

If you’re trying to help a young adult in your life build credit, a secured credit card is one of the best tools you can use to promote lifelong money habits.

What is a secured credit card?

A secured credit card works the same as a regular unsecured credit card, with just one difference: A secured card requires a security deposit for use as collateral. This deposit can be as low as $200 or $300 and is usually equal to your desired credit limit.

The credit card issuer holds onto the deposit in case you default on your payments. But with responsible use, the card can help you improve your credit score.

How does a secured credit card build credit?

The two most important factors in your FICO credit score are (a) your payment history and (b) your credit utilization, which is your card balance divided by your credit limit. Experts say these two factors make up about two-thirds of your overall credit score. As you use a secured credit card regularly and make your payments on time every month, you establish credit history through building payment history. In fact, if you pay off your balance in full each month, you can build credit without paying any interest on the account.

Also, by keeping your card balance at a reasonable level, you are demonstrating to creditors that you don’t need to rely on credit just to get by. A good rule of thumb is not to use more than 30 percent of your credit line each month.

Don’t confuse a prepaid debit card with a secured card when building credit

Essentially, the bank issuing a credit card loans money to the user/consumer and expects that money to be paid back. A secured credit card requires the user (or user’s guarantor) to deposit the amount of the full credit line in advance, so the credit card company knows it will always get paid on time. The cardholder will pay interest on the amount outstanding and is able to borrow successive amounts after they pay back the balance. Not all secured cards report to a credit bureau and you’re not really establishing a credit history when you take the pre-paid approach. On the positive side, you won’t go into the black hole of interest debt.

How do security deposits work?

A security deposit guarantees that the provider of goods and services will get paid even if the user walks away from the obligation. It is most often used when renting an apartment or a house. The landlord wants to know they will collect their rent, even if the tenant abandons the property.

Can you be denied a secured card? If so, why?

Even if the card user deposits the full amount of the credit being extended, it is possible for the credit card company to lose money. If someone has no income or cannot demonstrate the ability to make the payments, the credit card company will decline them.

How could a secured card potentially damage your credit?

If the card issuer takes your security deposit for failing to make your payments, it can be reported to the credit bureaus and hurt your credit rating.

Tips for using a secured credit card to build credit responsibly 

  • Make sure you can make the payments.
  • Pay off the loans quickly because of higher fees.
  • Keep a good record and convert to an unsecured card as soon as possible.

Most secured credit cards don’t offer a rewards program. That may not bother you if your top priority is building credit. However, if you want to get cash back, consider cards that offer that benefit as well as travel points. Managing credit card debt is one of the key building blocks to lifelong financial literacy.  Contact us any time if you’d like more guidance on credit card options for the teens or young adults in your life.

About Patrick Melvin Jr.

Patrick D. Melvin Jr., is a Wealth Manager at Independence Advisors, LLC. Pat models client’s financial plans and works with the firm’s clients on financial planning areas such as retirement planning, investment planning and estate planning. CLICK HERE TO ASK PAT.
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