How secured credit cards can build, or rebuild, your credit

Once a little-known option, secured credit cards for people with scant or poor credit are getting more attention.

Amazon, for instance, has just introduced a secured card called Amazon Credit Builder. Amazon said its new card was aimed at customers who were "looking to build or rebuild their credit responsibly."

Secured cards are used mainly by people who don't have much of a credit history, or have low credit scores. Borrowers make a refundable cash deposit — typically $200 to $500 — to "secure" the card's line of credit. The security deposit serves as collateral and sets a spending limit; users can make purchases on the card up to that amount.

Then, as the cardholder makes monthly payments — hopefully, on time — the bank reports them to the big credit bureaus, establishing a pattern of sound credit management that can improve the cardholder's credit score.

Keeping a secured card open for two years was associated with a 24-point increase in credit scores, the Federal Reserve Bank of Philadelphia reported.

Eventually, the borrower can "graduate" to a traditional credit card with a higher limit, and get the deposit back.

"Secured cards are the most affordable and widely available tool to help people with low or no credit scores to establish credit or improve their scores, if they use it properly," said Rob Levy, vice president of research and management at the Financial Health Network (formerly the Center for Financial Services Innovation), a nonprofit that promotes access to financial services.

The cards once were considered suspect. In the 1980s, fraudulent third-party brokers took finder's fees and security deposits from consumers but never issued cards. In 1988, more than 1 million Americans were victims, paying more than $50 million to brokers, while only 10% of them obtained cards, according to the Philadelphia Fed's report.

These days, the cards are considered a reputable way to build credit, but they remain underused. The Financial Health Network estimated that in 2015, there were fewer than 6 million secured card accounts, while about 108 million consumers could benefit from them.

That may be in part because some features, like the required cash deposit, make the cards hard for some people to use. Often, consumers who are approved for the cards can't cobble together a deposit, the consumer protection bureau reported.

Also, the low spending limit may make it difficult for people to use the cards in a way that significantly improves their credit score. A major component of credit scores is the proportion of available credit that a person uses. Users of secured cards must keep balances quite low — ideally, 30% of the cap — to lift their scores, Levy said.

Secured cards also usually charge annual fees, and may have higher interest rates than traditional credit cards.

Amazon's card, issued through Synchrony Financial, has no annual fee and offers a wider range of credit limits than most secured cards — as little as $100 or as much as $1,000, according to the company's website. Credit Builder users may be eligible to move up to an Amazon Store Card after seven months of on-time payments.

The Credit Builder card can be used only at Amazon, making it akin to store cards offered by brick-and-mortar retailers. Its interest rate is a relatively high 28.24%. (The average rate on credit cards for people with poor credit was 25.33% as of June 5, according to the card site Creditcards.com.)

Amazon Prime members, who pay an annual membership fee, are eligible for 5% cash back on purchases with the secured card. But cash-back features tend to encourage spending, which can lead to higher balances and a slower credit score improvement, Levy said.

Users should be particularly cautious about the card's special financing promotions, said Odysseas Papadimitriou, chief executive of the personal finance site WalletHub.com.

Credit Builder cardholders can, for example, get 0% financing for six months on purchases of $149 or more, or 24 months on purchases of $799 or more. Minimum monthly payments must be made.

Users who are new to using credit, Papadimitriou warned, may be unfamiliar with how such promotions work and end up owing more than they can afford.