Here’s how you can use secured credit cards to build your credit history

Credit unserved (408 million): They have no access to credit from financial institutions. They are typically excluded from the formal financial system due to factors such as a lack of credit history, low income, or living in remote areas. As a result, they are unable to borrow money or obtain credit cards from established banks or lenders.

Credit underserved (164 million): Access to credit is severely limited or restricted. For example, they may only qualify for small loans with high interest rates or unfavorable terms from non-bank financial companies (NBFCs). These customers often have lower credit scores, limited financial resources, or reside in economically disadvantaged areas.

One of the solutions for these hundreds of millions of potential customers is the issuance of secured credit cards. Lenders are cautious about extending credit to those without an appropriate credit history. By offering a path to credit for those consumers who have been previously denied that, these cards pave the way for enhanced financial opportunities, exposure and discipline.

What exactly is a secured credit card?

Secured credit cards operate exactly like regular credit cards, in terms of earning rewards, discounts and cashback on spends. The customer gets 15 to 20 days to make the payment for the spends of the previous 30 days. The difference lies wherein secured credit cards necessarily require a deposit or guarantee or a similar collateral. This distinctive feature sets these cards apart and offers an opportunity to establish creditworthiness and demonstrate responsible financial behaviour to individuals that lacked access so far.

How do secured cards work?

Secured credit cards operate on the principle of collateral, which can take different forms. One well-known collateral option is a fixed deposit. The amount deposited typically determines the credit limit, providing cardholders with a clear spending threshold. This encourages consumers to manage their expenses within their means and develop healthy financial habits.

In variant quantities, gold is available in most Indian households and can serve as an ideal collateral to secure credit cards. This approach not only benefits individuals who possess gold but also helps the financial sector. Presently, NBFCs like Rupeek have come up with gold collateralized credit cards where they offer up to 75% of the gold value as the credit limit.

Furthermore, secured credit cards can extend their reach by leveraging property as collateral. Small businesses with unpredictable cash flows, such as shopkeepers and young professionals, can benefit from this. Credit cards with a modest limit issued on the back of small ticket property would offer a road ahead for the less privileged, akin to an overdraft.

Currently, there are financial products that offer loans against securities like shares, mutual funds and life insurance policies. Credit cards could also be issued against aforementioned liquid assets. A conservative and innovative product design can solve for the swiftly changing dynamic value of such liquid assets. Quite naturally, regulatory approvals will be required.

Who can benefit?

These types of individuals can take advantage of secured credit cards: Individuals with limited or no credit history looking to build credit history, applicants who are rejected by banks due to poor credit health, young adults and students starting their financial journey, self-employed individuals and entrepreneurs with irregular income and retirees. By using secured credit cards, individuals can establish a positive credit profile by demonstrating responsible payment behavior. Once a good track-record has been built, these individuals can be eligible for unsecured cards with better terms and benefits.

Raj Khosla is founder and managing director, MyMoneyMantra.com

Updated: 20 Jul 2023, 11:07 PM IST