Secured cards are great for building credit. But after you've improved your credit score, do you still need the card?
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Secured credit cards are a really important credit-building tool. When you can’t get approved for a standard credit card because your credit score isn’t very good or because you haven’t had time to build credit history, a secured card could be your first card.
By using a secured card and paying it responsibly, you can develop a positive payment history that leads to a good credit score and one day allows you to take your pick of the best credit cards.
But what happens once you’ve developed that positive credit history? Should you keep your old secured card open or is it OK to close the card? The right choice will depend on your situation, but there are a six key questions to ask yourself before you make the decision.
1. How much of your money is tied up with the secured card?
Secured cards require you to deposit collateral in a special account with the creditor. Typically the amount you deposit is equal to your line of credit. So a card with a $500 line of credit would require a $500 deposit.
If you have several hundred dollars tied up with the secured card, closing it to get the cash back often makes sense -- especially if you need the money for some other purpose, such as creating an emergency fund. The more you have tied up with the card, the stronger the argument that you should close out the account and recover your funds.
2. How much will closing the secured card affect your credit?
While getting back your deposited collateral is one of the biggest reasons to close a secured card, preserving your credit score is the biggest reason to keep the card open.
If you have a secured card open but don’t charge anything on it, the card helps your credit utilization ratio. Credit utilization ratio is the amount of credit used vs. credit available. Plus for many borrowers, their secured card is one of their first credit cards on their credit report, which means it makes the account history longer. A low credit utilization ratio and a long credit history both have a big positive impact on your credit score.
Unfortunately, when you close out your account and your credit history and utilization ratio both change for the worse, your credit score could take a tumble.
3. Does the secured card have an annual fee?
Some secured cards don’t just cost you money by tying up your collateral -- some also charge an annual fee.
If you’re paying a fee for your card, this is a really strong argument in favor of closing it. After all, it makes no sense to pay a fee for the rest of your life just to be able to keep an old account on your credit history.