What is a Security Deposit? How Secured Cards Work and Can Help You Build Credit

Consumers with bad or no credit may have a difficult time qualifying for an unsecured credit card. Many issuers will reject their applications, and the ones that accept will impose high costs. Secured credit cards solve the problem by requiring security deposits.

A security deposit is the money you pay upfront to a credit card issuer when you open a secured credit card account. This deposit typically matches your credit limit. For example, if you pay a $200 deposit, your credit limit will be $200 (minus any upfront fees the issuer charges). The deposit protects the credit card company if you fail to pay your bill.

Security deposits are pretty straightforward. The card issuer puts your deposit into an escrow account as collateral against your credit card spending. Let’s dive into the details.

Issuers Set the Deposit Amount

Credit card issuers decide how much you need to put down for an initial security deposit and the maximum amount you can provide. Each issuer has its own policies, so the required deposit can vary. Many issuers offer a range of deposit amounts, letting you choose based on how much credit you need and can afford.

At least one issuer, Capital One, offers a semi-secured card, in which a deposit as low as $49 secures a $200 credit limit. Few, if any, other card issuers provide this arrangement.

The Deposit is Collateral Against Nonpayment

A security deposit acts as collateral for the credit card company. If you don’t pay your credit card bill, the company can use your deposit to cover your debt. This reduces the issuer’s risk. It also makes getting a credit card easier for people with bad or no credit. The deposit ensures the issuer can recover its money even if the cardholder defaults.

Most issuers do not pay interest on the deposited funds. They only use the deposited money to cover your bill if you miss a payment. When that happens, the issuer will withdraw money from the deposit account to cover the minimum payment and reduce your credit limit accordingly. You will need to deposit more funds to reestablish your total credit limit. 

The card company will likely close your account if you miss multiple payments.

Deposits Are Refundable

You can get your deposit back under certain conditions. One way is to close your account and pay off the balance. Another is to upgrade to an unsecured credit card, which doesn’t need a deposit. 

The issuer will refund your deposit if you meet these conditions and your account is in good standing. You must maintain a good payment history to qualify for a full refund. 

Some issuers automatically review your account after a certain period to see if you’re eligible for an upgrade and a deposit refund. Alternatively, the issuer may raise your secured card’s credit limit without an additional deposit — your card becomes semi-secured. 

At least one issuer rewards timely payments by sending you an unsecured card while keeping your secured account open. You’ll have two credit cards, although you can close the secured card for a refund if it suits you.

Secured credit cards have several benefits and drawbacks. The following list of pros and cons can help you decide if one is right for you.

Benefits

• Building or Repairing Credit: Secured credit cards help you establish or repair your credit score. Making regular, on-time payments shows that you can manage credit responsibly. Most secured credit cards report your payment history to the three major credit bureaus. Positive information can improve your credit score over time. A higher credit score can help you qualify for better financial products, including credit cards and loans, in the future.
• Learning Financial Discipline: A secured credit card can teach you financial discipline. Since you have to pay a security deposit, you become more aware of your spending. You learn to keep track of your purchases and stay within your credit limit, and that paying your bill in full monthly helps you avoid interest charges and debt. These habits are essential for managing any credit card.
• Access for Individuals With Bad or No Credit: Secured credit cards are available to consumers with bad or no credit. Because the deposit reduces the issuer’s risk, it is more likely to approve your application. This makes secured credit cards a practical option if creditors have denied you other types of credit. You can start building or repairing your credit history with a secured credit card without regard to your past financial challenges.
• Transition to Unsecured Credit Cards: Using a secured credit card responsibly can lead to you qualifying for an unsecured card. Many issuers periodically review your account. If they see a good payment history and improved credit scores, they may offer you an upgrade to an unsecured credit card. This means you won’t need to deposit more and may receive a higher credit limit.
• Establishing a Relationship with the Bank: A secured credit card can help you build a relationship with an issuer, bank, or credit union. This can benefit your finances in the long term. A good relationship with your bank can make getting approved for loans, better credit cards, and other financial products easier.
• Lower Costs: Many secured credit cards have lower APRs and fees than unsecured cards for bad credit. For example, secured cards never impose monthly maintenance or signup fees. For those with poor credit, unsecured cards are notorious for charging these fees. In addition, the APRs for secured credit cards seldom exceed 30%, whereas some unsecured cards charge up to 36%.

Drawbacks

• Upfront Deposit: Secured credit cards require an upfront security deposit. This can be a drawback if you don’t have any money to set aside. The refundable deposit usually equals your credit limit, so a higher limit means a larger deposit. Some secured credit cards also have annual fees. It’s essential to consider these costs before applying.
• Limited Credit Limits: At least initially, secured credit cards may have lower credit limits. Your limit is usually equal to the amount of your security deposit. This determines your purchasing power. You have to increase your deposit if you need a higher limit. Limited credit limits can also affect your credit utilization ratio, which is the amount of credit you use compared to your total credit limit. Keeping this ratio low (i.e., below 30%) is vital for a good credit score.
• Potential Loss of Deposit: You risk losing your deposit if you can’t pay your credit card bill. If you miss payments, the issuer can use your deposit to cover your debt. This means you may not get some or all of your deposit back. Additionally, missing payments can harm your credit score. You should only apply for a secured (or unsecured) credit card if you can make the payments.

The following chart should help you decide whether to apply for a secured or unsecured credit card:

I advise consumers with bad credit to get a secured credit card first. Their deposits are refundable, acceptance is easier, and costs are typically lower. Switch to an unsecured card only when the issuer upgrades you or after you boost your credit score.

Selecting a secured card is easiest if you have side-by-side comparisons of available products. Let’s examine what to look for:

Compare Interest Rates and Fees

When comparing secured credit cards, look at the interest rates and fees. The interest rate, or APR, is the cost of borrowing money on the card. Lower interest rates mean you’ll pay less if you carry a balance (something you should avoid if possible). 

Additional costs can include annual fees and late charges. Some cards may waive the yearly fee entirely or suspend it for the first year. Always read the terms and conditions to understand all potential costs. 

Check Minimum and Maximum Deposit Requirements

Different issuers have different deposit requirements. Some cards require a minimum deposit of $200, while others may allow you to deposit more for a higher credit limit. 

The minimum deposit is the least amount you can pay to open the account. The maximum deposit is the most you can put down (in some cases, $5,000 or more).

Consider how much money you can afford to set aside for the deposit. A higher deposit will give you a higher credit limit, which can help you spend more or improve your credit utilization ratio.

Evaluate Additional Benefits or Rewards

Several secured credit cards offer additional benefits or rewards, such as cash back, points, and travel benefits. Look for cards that offer rewards for the purchases you make most often. 

Other benefits may include fraud protection, free credit score monitoring, or rental car insurance. Compare the benefits of different cards to see which ones match your needs. Choosing a card with good benefits makes more sense.

Security deposits help credit card issuers by acting as a financial safety net. They allow issuers to offer credit to people with bad or no credit, which can help cardholders build or repair their credit history. By lowering the issuer’s risk, security deposits provide more equitable access to credit.

Secured credit cards are a reasonable first step to a better financial future. Just pay on time and keep your balances low. Whether you’re new to credit or recovering from bankruptcy, responsibly using a secured card can improve your credit score and financial outlook.