In most cases, when you apply for a credit card, you’re applying for an unsecured credit card. An unsecured credit card has a predetermined credit limit that you don’t have to secure with an asset or deposit, and your credit limit is determined by how credit-worthy your lender judges you to be.
But what happens if your lender deems you too risky for an unsecured credit card? Rejection can happen if you have a bad credit rating or no credit rating at all. It’s more common than it sounds, especially for newcomers to Canada, students, or Canadians dealing with divorce, bankruptcy, or a consumer proposal.
You may be a candidate for a secured credit card if your credit rating is low. Your credit rating is a number between 300 and 900. Most financial institutions require you to have a credit score of at least 600 to qualify for an unsecured credit card. Otherwise, a secured credit card is a good way to build up or establish your credit rating and get into your lender’s good graces.
Secured credit cards
Secured credit cards require a deposit to secure your loan. You pay a deposit to your lender, usually one or two times the amount of your credit limit, and the lender holds this deposit and extends you a credit card in return. While you’re using the credit card, your lender will keep the deposit, but they’ll pay you interest, and some lenders will even place your deposit in a GIC for you.
Who should use a secured credit card
As we mentioned above, secured credit cards are perfect for Canadians who haven’t yet established a credit history, such as newcomers to Canada and students. It can also be a good choice if you have a credit rating that’s below 600. You can still apply for a secured credit card if you’ve been discharged from bankruptcy.
Applying for a secured credit card
When you apply for a secured credit card, you’ll have to pay a setup fee, usually a percentage of your credit limit. For example, if you apply for a secured credit card with a credit limit of $2,000 and the setup fee is 3%, you’ll have to pay $60. You’ll also need enough cash on hand to pay the deposit, which is usually one to two times the amount of the credit limit. In the example above, you’d need $2,000 to $4,000 on hand to give to your lender after approval, for a total of up to $4,060.
Unlike unsecured credit cards (from which there are dozens to choose), the secured credit card market is limited. Many financial institutions offer secured cards, including Capital One Canada, Peoples Trust, and Home Trust.
Using a secured credit card
Once you’ve been approved for your secured credit card and paid your deposit and setup fee, you can start using your secured credit card to build or rebuild your credit rating. You can use a secured credit card exactly as you would an unsecured credit card. Some secured credit cards have higher interest rates than unsecured credit cards so you should pay off your balance in full at the end of every month.
Life after a secured credit card
A secured credit card is a stepping stone for Canadians with no credit rating or a bad credit rating. If you’ve been approved for a secured credit card, now is your chance to prove to your lender that you’re capable of using credit responsibly. You should pay off your credit card every month, if possible, and if you can’t, you should keep the balance to less than 35% of your credit limit.
If you do this, eventually you’ll qualify for an unsecured credit card. You’ll get your deposit back (plus interest), and you’ll enjoy the benefits of an unsecured credit card, including signup bonuses and rewards points. It usually takes between 12 and 18 months to qualify for an unsecured credit card. How soon you qualify will depend on your credit rating, your repayment history and how comfortable your lender is with your personal finances.
Flickr: Ciaran McGuiggan