D Stanley's answer addresses the mechanics of secured cards well and does a good job of directly answering your question. I wanted to post a separate answer to provide a bit of a frame-challenge to your assertion that secured cards are a "horrible" product, because I don't think that's reflected in the facts and the data around how consumers and lenders use this type of product when it's implemented as intended. (While some lenders may use secured cards to take advantage of consumers, that happens with all types of products and I don't think that counts as a fair representation).
You are correct that secured cards are typically aimed at people who have poor credit and cannot use other types of credit. Lending in the US is typically based on a number of factors:
- Understanding a consumer's cash flow. People need to prove that they have income to pay back their creditors. This is typically done via either consumer-volunteered data (i.e. a box on an application that says "Income:") or via more direct income verification (i.e. providing pay stubs, tax returns, etc). Typically, income is balanced against outstanding debt, which again is often consumer-supplied and/or verified externally (via a credit report).
- Understanding a how a consumer behaves, in terms of lending risk (will they pay their bills on time?) This is done via credit scoring, which you've referenced in your question. The credit scoring system in the US is based on using data to predict the likelihood that a consumer will default on a new loan in the near future. The models are trained to consider "unknown" similarly to "bad" in the sense that a consumer with no history is treated similar to a consumer with bad history.
Your question really hinges on the second point - understanding the risk that a consumer presents to the lender. Lenders use credit score in two ways - first, to determine if they will approve a loan for a consumer, but secondly to help them price a loan. Loans are priced higher for riskier consumers.
The model generally works in the sense that it helps lenders make decisions about consumers. However, the model also presents a problem - if a consumer has no credit history, or a poor credit history, they may have a score that is so low that no lender will even lend to them. Lenders can't just price a traditional credit card high enough to cover the risk, because interest rates are capped by law. Hence, people with very poor credit scores essentially have no way to get back "in to the system" where they're scored high enough to obtain typical consumer loans. For someone trying to get to the point of buying a home or making another major credit commitment, this can be very limiting.
That's the problem a secured card is designed to solve - it provides a loan type that's backed by collateral (the deposit) and hence can be priced appropriately, even for consumers with very bad credit scores. In many cases, it may be the only credit someone can obtain.
On the surface, a secured card may make no sense - why put down a deposit just to get a credit card, when you could just manage your own money? The secured card isn't intended only to replace a traditional card, it's intended mostly to provide a stepping stone to allow a consumer to get to good standing. In that sense, while it may be easy to criticize a product aimed at people in poor standing, another viewpoint is that you're throwing them a lifeline and allowing them to build a better financial picture for themselves.
And, when looking at trends in consumer data, that is how things basically play out. From a lender's perspective, the deposit has a direct impact on the risk of the loan because it is available as collateral for the lender to take if the loan is not paid back. But, that's not the full picture - the deposit also typically creates a change in behavior among consumers. People who put a deposit down feel more invested, because they have something at stake. If you've already got poor credit and you walk away from a loan, you may feel like you're not losing anything. But if you've got poor credit and you walk away from a loan and a cash deposit, that hurts a bit more! People who take out secured card loans are more likely to pay them back than their peers who take out traditional credit cards. That's good, because the pricing and approval process shifts even further than it would when just considering the collateral offset to risk.
It's also good because the consumer is learning good habits, by training themselves to respect the loan and pay it back on time. Consumers who intend to use a secured loan to rebuild their credit typically end up in better standing in the long term than those who don't.
So, while it may be easy to write it off as a "horrible" product, when implemented correctly, it's essentially the opposite that is true. When a consumer intends to rebuild their credit, a secured card can often be the best tool they have available to them.
