In this post, I shall address the question of what is a secured credit card. A secured credit card is different from a regular credit card because you are not actually given credit. But how is this so?

To get a secured credit card, you would need to deposit a balance with the credit card issuer. This amount normally ranges from $200 up to say $15,000. The credit card issuer will then use this as a colleteral and give you a card limit based on the amount of your deposit. Most credit card issuers will allow to charge to your card up to an amount that is equivalent to your deposit amount. You will earn interest on your deposit, but you cannot withdraw it as it acts as the issuers collateral in case you default on your payments.

Who should apply for a credit card?

Secured Credit Cards are meant for those who have bad credit or no credit. For those who have bad credit or have just come out of bankruptcy, then getting a secured credit card is a roadmap back to rebuilding one’s credit. The reason why credit card issuers are willing to issue a secured credit card to those with poor credit is because they have the deposit as a collateral.

If you have no credit, or never had a credit card when you were in college, a secured credit card allows you to start building a credit history.

Secured Credit Cards have lower costs than sub-prime credit cards

One of the main advantage of a secured credit card over a regular sub-prime credit card is that is has lower fees. Most subprime cards charge a one-time application fee, a monthly maintenance fee plus even an annual fee. Most secured credit cards simply have a reasonable annual fee and that’s it.

Things to beware of

1. When you apply for a secured credit card, you have to be aware of a few things. Firstly, you have to make sure the credit card reports to the three main credit bureaus, TransUnion, Experian and Equifax. This is so that you can build or rebuild your credit.

2. You also want to make sure the card pays you an interest on your deposit.

3. You make to have an upgrade path to a regular unsecured credit card with no annual fee. That is why it is very important to get a secured credit card from a major credit card issuer or bank and not a “sub-prime credit card issuer”.

I got this letter from a reader.

Qn : Hey Mr Credit Card - I have 5 credit cards with $25,000 debt on all of them. I have been paying my bills on time and my fico score is still good. But my debt is too high for my liking and I would like to get rid of my credit card debt. I’ve heard that getting a debt consolidation loan or a home equity line of credit will reduce my monthly interest payment. What is your opinion on this matter? - Julie.

Ans : Julie - Since you have a good credit score, I would not get a home equity line of credit (HELOC) even though you may “save” a little on your monthly interest cost. The reason is because any HELOC is a secured debt just like your mortgage. If you miss on your payments, you may face foreclosure. In contrast, your credit card debt is unsecured debt. If you default on your credit card payment, the credit card company cannot force you to sell your house. Your credit will take a hit, but your house can never be foreclosed.

Here are the steps I would take to reduce credit card debt.

1. Instead, I would recommend applying for a 0% apr balance transfer credit card and transfer the balance from the card with the highest apr. I recently wrote a post on How to choose a balance transfer credit to help reduce your credit card debt, which you should check out.

2. List the credit cards from the highest apr to the lowest (the 0% card will be the lowest). Your goal should be to eliminate the debt from your highest interest rate credit card first, and then moving on to the next highest apr card until you have completely eliminated your credit card debt.

3. Document and write down the minimum payment you will pay for all credit cards. Set that amount now and pay that amount every month for all credit cards. Over time, you will be paying higher than the minimum requirements every month because you will be reducing your principal.

4. Take the savings from you get from the balance that you transferred to the 0% balance transfer card and use that extra savings to pay off the card with the highest apr card.

5. Once, you pay off the card with the highest apr, use the extra money that would have been used for the payment to that card and increase your payment on the next highest apr credit card.

6. Wash, rinse and repeat the process.

Other things to take note of

You also want to consider these other points. Firstly, use your lowest apr credit card to charge your daily expense. Pay off that amount every month. Do not use your 0% balance transfer credit card because you should be transferring a balance up to the maximum credit limit for that card.

Secondly, make sure you pay your bills on time (especially for your new 0% apr credit card) because your apr will increase to the default rate should you miss your payment. With universal default clause, your apr on ALL your credit cards may increase if you miss even one payment on any debt obligations.

Thirdly, you can reduce your credit card debt faster if you set a budget and reduce your monthly expense. Look for ways you can save money. For example, consider getting a VOIP phone provider rather relying on your traditional phone carrier. Consider getting Vonage as they are the largest VOIP provider and is much cheaper than traditional phone plans (I personally use vonage and would recommend it). Consider getting coupons from coupon sites to get discounts on your purchases.

I do not know the rates on all your credit cards so we cannot calculate how fast you can eliminate your credit card debt. But if you stick to this strategy, you will get rid of your credit card debt before you know it.

Much has been written about arbitraging 0% balance transfer deals offered by credit cards. While 0% balance transfer deals have been used to entice consumers to applying for a new card, some savvy consumers have long used these deals to make “free money”. Here is how this exactly works.

First, let’s make a few assumptions.

1. You do a balance transfer of $10,000 (for easy computation purposes).

2. You can take this amount and put it in a bank account that earns 4.5%.

3. The balance transfer deal is for 12 months (or 1 year).

4. Let us further assume that there are no balance transfer fees.

Firstly, if you take $10,000 for the credit card issuer and put it in a bank account (fixed deposit?) for 1 year earning 4.5%, you will receive $450 after one year. Assuming that your tax bracket is 30%, then you get $315.

For the balance transfer, you have to pay 4% of your balance transfer amount to maintain the 0% deal. Hence, during the first month, you pay back the credit card issuer $400 (0.04 X $10,000). After the first month, the remaining balance is $9,600 and you have to pay 4% of $9,600, which is $384. Below is the table illustrating the cash flows.

Balance Transfer——>Payment (4%)—->Month
$10,000——————–>$400 ——————>1
$9,600 ———————>$384 ——————>2
$9,216 ———————>$368.64————–>3
$8,847.36—————–>$353.89————–>4
$8,493.47—————–>$339.74————–>5
$8,153.73—————–>$326.15————–>6
$7,827.58—————–>$313.10————–>7
$7,514.47—————–>$300.58————–>8
$7,213.90—————–>$288.56————–>9
$6,925.34—————–>$277.01————–>10
$6,648.33—————–>$265.93————–>11
$6,382.39—————–>$255.30————–>12

Total Minimum Payments made over one year is $3,872.90.

At the end of one year, you get $10,450 from the bank (principal plus 4.5% interest). You will then use $10,000 to pay off your remaining balance (actually, your remaining balance is $6,127.10 and $3,872.90 is the amount that you keep and is the amount that you paid on your minimum balance over the year).

Hence, $450 in your pocket, which is essentially risk-free arbitrage. This figure will be less depending on your tax bracket. It will also be less if you are charged a balance transfer fee. Your return on capital is infinite as there is theoretically zero financing cost and zero capital outlays if we look at the picture at the end of one year. But in reality, you need to pay the 4% minimum balance every month and your net cash flow is negative for one year until you withdraw the original principal and interest from the bank account.

However, for this to work, you have to bear a few things in mind.

1. Some credit cards only allow you to do a “proper balance” from another “higher rate credit card”. You need to find a credit card that will write you a balance transfer check or advance check.

2. You will have to pay on time and not miss a single payment. If this happens, your apr will go from 0% to either normal or default rate (very high). If you miss a payment to any other creditor and it is reported in your credit report, the universal default clause can be used by the credit card issuer to cease your 0% deal.

3. You cannot pull this off too often as there is a limit on the number of credit cards you can apply in a short period.

4. Under most terms and conditions, credit cards have the right to raise the apr from 0% to whatever they please without explanation.

Frankly speaking, for just a couple of hundred dollars and the hassle you have to go through, I would not even bother with this. Having said that, for those with quite a bit of credit card debt but still have a good credit score, getting a credit card with a 0% balance transfer deal makes sense as it reduces your interest cost quite a bit. You should then use the savings from the 0% deal and pay off the card with the highest interest rate.

My final thoughts are that 0% balance transfer deals should be used by those who want to reduce their credit card debt and still have good credit. Playing the arbitrage is just too much of a hassle for a couple of hundred bucks.

FAQ : I am looking for a low interest rate credit card. How do I look for one and what should I be looking out for?

Answer : This is a common question I get from my readers, so I shall attempt to write a few notes on this. Firstly, before you attempt to compare credit card rates, check your own credit scores. Someone with a 750 score will get a much lower rate than someone with a 600 score. From that perspective, the rate that is advertised by credit cards is less relevant because you may get a different rate based on your own score.

Secondly, if you carry a balance every month, you should prefereably get a credit card that uses the average daily balance method to calculate monthly balance. Most credit card issuers include new purchases within the billing cycle in their calculations. You should avoid cards which use the 2-cycle average daily balance method if your balance fluctuates or if you plan to gradually reduce your monthly balance and be credit card debt free. This is because your monthly balance will be the average of the two billing cycles and you have higher balances than if you had used a card that does not use the 2-cycle method. For a more detailed look at this, you can read my previous article on The effects of the 2-cycle average daily balance method on your monthly balances.

The next factor to consider is whether your credit card uses the daily periodic rate or monthly periodic rate. This is often an overlooked factor. Assuming two cards with the same apr, the card that uses the monthly periodic rate will have a lower effective interest rate than the other card that uses the daily periodic rate. This is due to the compounding effect. Check out the article I wrote on How to calculate your effective interest rate on your credit card.

The next thing to look out for is the grace period. Previously, most credit card issuers gave you a grace period of 25 days. The grace is the number of days you are given before an interest charge is imposed if you do not carry a balance. These days most credit cards have a 20 days grace period although there are still cards which give you a 25 days grace period.

The last thing to consider is whether a credit card has any annual fee. While most credit cards do not have annual fee, some cards like the Pulaski Bank Credit Card have very low interest rates, 25 days of grace period, uses the monthy periodic rate, but has an annual fee. Other cards like the Bank of America Rewards American Express Card has a very low interest rate, no annual fee, 25 days of grace period but uses the daily periodic rate.

To sum up, if you are looking for a low apr credit card,