Secured Credit Cards and Bankruptcy

In every type of bankruptcy, the court treats secured debts and unsecured debts differently. A secured debt is a debt that’s secured by some of your property. The property is called collateral. If you don’t pay the debt, the creditor can take the collateral from you. For example, a car loan is secured by your car. If you don’t pay, the lender can repossess your car. Unsecured debt, such as medical bills and most credit card debt, isn’t secured by any collateral.

Secured credit cards are treated differently under bankruptcy law than ordinary credit cards. This article covers how secured credit cards work, what happens to your secured cards when you file bankruptcy, and how a secured credit card can help you rebuild your credit after bankruptcy. 

What Is a Secured Credit Card?

You probably already know that making on-time debt payments each month is key to having a good credit score. But it’s hard to make on-time payments if banks won’t offer you credit. It’s a classic Catch-22: Your credit score is too low to get a loan but to raise your credit score, you need to make payments on a loan each month. Secured credit cards are designed to provide a way out of this cycle.

When you apply for a secured credit card, you’ll pay a cash deposit to the lender. Your credit limit on the card is usually equal to the amount of the cash deposit. The cash deposit becomes the collateral that secures the debt you charge on the card. If you don’t pay your bill, the lender can take some or all of the deposit. 

You can use a secured credit card anywhere, just like you would use a traditional credit card. After a while (typically around 12 months), the card issuer may refund your deposit and convert your card from secured to unsecured. 

Is a Secured Credit Card Right for Me?

If you have a low or very low credit score due to missed payments, default, repossession, or other negative credit events, you may not qualify for a traditional, unsecured credit card. Likewise, if you’re new to credit and have a sparse or nonexistent credit history, your credit options are probably limited. The requirements to qualify for a secured card are typically much lower than for traditional credit cards. This is because the security deposit significantly reduces the lender’s risk if you don’t pay the bill.

A secured credit card can be a good way to improve your credit score by allowing you to build up a positive payment history (more on that later). Keep in mind that the credit limit on these cards is often low, and the interest rates tend to be high. In other words, a secured credit card isn’t a good choice to finance a major purchase. Secured cards work best when you use them for minor purchases and pay the balance in full each month.

How Do I Choose the Best Secured Credit Card?

The secured credit card industry is competitive. Like traditional credit cards, many secured cards offer reward programs, cash-back options, and discounted introductory interest rates to win your business. When you’re researching secured credit cards, start with your local bank or credit union, especially if you already have an account there. You may find a better offer than with large national lenders. The key factors to consider when comparing cards include:

• Interest rates: Lower is better. If there’s a special introductory rate, read the fine print to find out when the introductory rate ends and what the permanent rate will be.

• Reporting policy: A secured card will only help raise your credit score if the lender reports your on-time payments to the credit bureaus. The ideal lender will report to all three major credit bureaus (Equifax, Experian, and TransUnion) regularly.

• Added fees: Avoid lenders who charge application fees or high annual fees.

What Happens to Secured Credit Card Debt in Bankruptcy?

Traditional credit cards are unsecured. Most unsecured debts are eliminated in bankruptcy. You can’t keep a traditional credit card after filing bankruptcy, even if the payments are current or the card has a $0 balance. Secured credit cards, though, are different. Bankruptcy laws don’t treat secured credit cards like traditional credit cards. Instead, secured cards are treated like other secured debts. Secured debts are treated differently depending on which chapter of bankruptcy you file.

How Are Secured Credit Cards Treated in Chapter 7 Bankruptcy?

When you fill out your Chapter 7 bankruptcy paperwork, you’ll complete a form called the Statement of Intention. You’ll list all your secured debts on this form and indicate whether you intend to keep the collateral and keep paying the debt or give up the collateral and eliminate the debt. 

If you want to keep your secured credit card, you must be current on the payments. Your lender may ask you to sign a reaffirmation agreement promising to keep making your payments after the bankruptcy. If you don’t want to keep your secured credit card, any balance you owe will be wiped out and your lender will close the account. Your lender can keep your security deposit (up to the amount of the debt).

How Are Secured Credit Cards Treated in Chapter 13 Bankruptcy?

The lifeblood of a Chapter 13 bankruptcy case is the repayment plan. Your plan must list all of your secured debts, including your secured credit card. If you want to keep the card, you’ll have to pay the card balance, plus interest, in equal payments over the full plan term (between 36 and 60 months). The interest rate you’ll pay through the plan will usually be lower than the interest rate in your cardholder agreement. If you don’t want to keep the card, your plan should specify that you want to surrender the security deposit and pay $0 on the debt.

What About My Security Deposit?

The security deposit you paid when you opened your secured credit card account is the collateral that secures the card debt. When you complete your bankruptcy forms, you’ll need to list the deposit on Schedule B along with your other property. Exemption laws allow you to protect some or all of your property from being taken or sold in bankruptcy. Each state has its own exemption laws. There are also federal exemptions. 

Because most secured card deposits are relatively small, you’ll likely be able to claim your entire deposit as exempt. Be sure to list your deposit among your other claimed exemptions on Schedule C in your bankruptcy paperwork.

How Can a Secured Credit Card Help Rebuild My Credit After Bankruptcy?

Bankruptcy eliminates many debts, which allows you to move forward toward creating a strong financial future. Still, you’ll need to invest some time and effort into rebuilding your credit and improving your credit score. Establishing a steady pattern of on-time payments is one of the best ways to increase your credit score, But to do that, you’ll need a loan or credit card. You’ll likely qualify for a secured credit card even if you aren’t eligible for most traditional loans or cards.

To get the most credit-boosting benefits from your secured credit card, make your payments on time each month. This means you’ll need to use the card regularly, but keep the balance small so you can afford the payments. A good strategy is to use your secured card for minor monthly expenses, such as utilities or fuel, then pay off the balance each month. The more on-time payments you make, the better your credit score will become. Also, consider alternative methods to increase your credit score, such as using a credit builder loan or enlisting a co-signer to get a traditional loan or credit card.

Let’s Summarize…

When you open a secured credit card account, you give the lender a cash deposit as collateral for the card debt. Because of this collateral, secured credit cards aren’t treated like other credit cards under bankruptcy laws. Instead, bankruptcy courts treat secured credit cards like other secured debts. This means you may be able to keep a secured credit card even after filing bankruptcy.

Secured credit cards are often available to people who don’t qualify for traditional credit cards or loans, including people who have recently filed bankruptcy. Secured credit cards can be a great way to raise your credit score by giving you an opportunity to build a history of on-time debt payments.