What are secured credit cards, and are newer ones like Neo Financial’s a better option?

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As high interest rates continue to hammer indebted Canadians, credit councillor Becky Western-Macfadyen is seeing a larger number of Canadians using her services, and she’s recommending secured credit cards more as a result.

Secured credit cards are for people who can’t qualify for a regular credit card, either because they have a bad credit score or have no credit history as they’re new to Canada.

Ms. Western-Macfadyen, manager of financial coaching with the non-profit credit counselling agency Credit Canada, said she’s anecdotally seen a rise in interest for secured credit cards as more Canadians seek help with their debt during this era of high interest.

The organization saw a 27 per cent growth in clients using their debt consolidation services between 2021 and 2022. In the first six months of 2023, it has already served 20 per cent more clients than the first six months of 2022.

Unlike a regular credit card, secured credit cards require you to make a deposit, which becomes your credit limit and a collateral for the issuer. Because of the collateral, even people with extremely poor credit scores can qualify.

Your activity is reported to credit bureaus such as Equifax Inc. and TransUnion – unlike prepaid credit cards – which means you can build your credit score to eventually qualify for ordinary credit cards, mortgages or other loans.

Ms. Western-Macfadyen said secured cards are one of the best ways to build credit. Other options exist, such as loans that are inaccessible but appear on a person’s credit history, but she says these can be more expensive and they don’t actually give people access to credit.

Capital One and Home Trust were among the only institutions that offered secured credit cards. But recently multiple new players have entered the sector, in which there are only a handful of options, according to Ms. Western-Macfadyen.

Neo Financial CEO Andrew Chau said his company started offering secured credit to capture markets left behind by larger financial institutions, such as newcomers to Canada and those trying to rebuild their financial lives.

But is the Neo secured credit card worth getting?

First and foremost, personal finance expert Barry Choi said secured credit cards should only be used by people who are unable to get any kind of regular credit card. He said students or newcomers to Canada can sometimes qualify for some basic credit cards that major banks offer, and people should go for these first.

Generally speaking, secured credit cards come with compromises: the interest rates can sometimes be higher, they’ll often charge higher fees for features like foreign conversion, they usually don’t have rewards points or cashback, and they generally charge you for the ability to build your credit.

Take Capital One for example. It’s perhaps the biggest name when it comes to rebuilding credit and secured credit cards, and it’s also the company Mr. Choi generally recommends because the company makes it easy to track your credit score.

But it also charges a $59 dollar annual fee, doesn’t offer any cashback rewards and has a slightly higher interest rate of 21.9 per cent (compared with standard cards that generally offer rates around 19.9 or 20.9 per cent right now).

Ms. Western-Macfadyen says the Neo card is an ideal option because it doesn’t charge an annual fee and offers all the same cashback rewards as its regular credit card, which the company says can average out to 5 per cent.

Calgary’s Neo Financial raises $185-million led by Peter Thiel’s Valar Ventures

Mr. Choi takes issue with Neo’s advertising around the claim of an average of 5 per cent cash back. It’s true that you can get cashback as high as 15 per cent at some partner retailers, but these are specific retailers like the car rental company Budget, Canadian clothing brand Frank and Oak and furniture store Structube, which you may not always shop at.

Neo does guarantee you’ll get at least 0.5 per cent cashback on all purchases. That’s fantastic in the secured credit market, but other regular credit cards such as those offered by Tangerine or American Express could offer much better cashback value when you eventually graduate to real credit cards.

There are three other perks that the Neo card doesn’t offer: It only reports to one of the two major credit bureaus, it doesn’t offer the ability to track your credit score on their platform and it doesn’t allow you to have a credit limit higher than your deposit for users who consistently pay their debt on time (some institutions such as Capital One offer this feature, depending on the user).

However, Mr. Chau says changes are coming to remedy all those shortcomings.

Lastly, Neo’s interest rate can be as low as 19.99 per cent for some customers. That’s pretty good compared with Capital One, but if low interest rates are your biggest concern, companies like Home Trust and Plastk offer a lower interest rate if you’re willing to pay an annual fee.

Like any financial product, Neo Financial’s secured credit card isn’t perfect. But it does seem like a strong option for those who value having no yearly fee and some form of a rewards program.

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