You may have heard of unsecured credit cards, but what are they? Learn what they are and what makes them different from secured credit cards.
Unsecured credit cards are credit cards that are not backed by any collateral. Most people with good credit will get an unsecured credit card. This is the industry norm. By contrast, secured credit cards require collateral, typically a deposit. They are more common for people with poor or no credit.
Take a closer look at the differences between secured and unsecured credit cards to better understand your options.
What Is the Difference Between a Secured and an Unsecured Credit Card?
Learning how to utilize credit and make the most of your available credit cards may seem daunting. It can be even more difficult when you discover you are having a hard time simply getting a credit card.
Just take it one step at a time and consider the different credit cards available carefully. One of the most important distinctions to understand is the difference between secured and unsecured cards.
A Quick Overview
When people are referencing credit cards, they generally mean unsecured cards. This is a credit card that you do not have to post any sort of collateral for. Collateral is typically in the form of a cash deposit to get approved. Unsecured credit cards are more common than secured credit cards. Lenders only have your word that you will pay the debt back.
With that in mind, take a closer look at the differences between secured and unsecured cards.
Loans traditionally require a form of collateral. With collateral, the lender has a reduced risk of losing the money they loan should you not pay them back. For example, a home mortgage or car loan is backed by either the house or the car itself. If you fail with your payments, there will be a man repossessing your car, or the bank will post a sign and foreclose on your home.
If you go to the pawnshop, you may post an item for a loan. If you don't pay the loan back by an agreed time, the item may get sold. These loans are referred to as secured loans.
No Deposit Required: Unsecured Loans
In the case of unsecured credit cards, there is no collateral required. The lender or card backer simply takes your word you will pay for the purchases made. To manage their risk, you have to qualify for these loans. It is harder when you have no credit history or bad credit history.
Credit history is a record that essentially gives lenders an idea of how likely you are to pay your debt back. If you have a poor track record or simply no record at all, lenders are less inclined to give you money.
Because the largest portion of credit cards are unsecured, you rarely hear anyone using the word unsecured. That is except when it becomes important to distinguish between secured and unsecured cards.
How Does an Unsecured Credit Card Work?
As discussed above, an unsecured credit card will not have a deposit or any collateral to seize should you stop making your payments.
These cards will charge annual fees and have higher percentages to help offset the potential risk involved with lending.
The lenders weigh your risk using a variety of tools. The most common are national credit reporting agencies. These give you a credit score. Your credit card lenders use these scores to determine how much of a risk you are and raise or lower their rates accordingly.
Some cards offer larger rewards the higher your credit score is. Because of this, it can really benefit you to learn to help boost your score. You can learn many habits and tips to follow to bump your credit up. Don't worry; you can still get a card if you have no credit or simply no credit history.
Secured Credit Cards
One card you can get when you have a poor credit history or don't have any credit history is a secured card.
Collateral is given in the form of a cash deposit upon opening the account. Your credit limit is generally what you have placed as a deposit. Your lender has a minimal risk because you can't put more on the card than your deposit.
If you default on payment, your deposit is simply taken. Secured credit cards are popular for people who are looking to build better credit and have limited choices.
Who Can Get an Unsecured Credit Card?
Most of the big-name cards that are commonly used are unsecured. Department stores that ask if you want to apply for their card are offering you an unsecured credit card. This goes with most offers that come to you through the mail or in a store.
You generally will need to have at least good credit, if not excellent credit, to get one, however. The cards with the best rates and best rewards will need excellent credit to qualify for. If your credit is fair, you can still apply to a number of fantastic unsecured credit cards that have no annual fee or offer rewards; in some cases, both!
What About Bad Credit?
There are many people that don't have the best credit.
Where does that line fall? Bad credit is generally described as 629 or below for a score. There are cards you can still apply for. These are not as highly recommended, which is why it is ideal to have a better credit score.
People with poor credit typically only have unsecured cards available that have high fees and low credit lines. If they are patient, there can be smarter ways to build credit than through these cards.
This is because they also commonly charge annual fees, even for credit limits of a few hundred dollars. If you default, you will see these fees add up quickly.
If not managed, you can easily pay much more for something that was initially a small purchase. Additionally, unlike secured card deposits, these fees will not be given back to you. If you choose to get a secured card, your deposit comes back to you after an agreed-upon time.
What About No Credit?
There are options for people who are looking for a credit card but have no credit history, whether good or bad. There are companies that offer unsecured cards for those without a credit history.
They choose to turn their focus away from credit reports and credit scores. Instead, they turn to their applicants' bank account balances, income, occupation, and in some instances, even the college they went to and what they studied.
Which One to Choose
As a general rule of thumb, most people who can get an unsecured credit card will do so. If you aren't approved for an unsecured credit card that has reasonable fees, then you are likely to get a secured card.
That being said, there are a few important things to keep in mind when directly comparing the two types of cards.
More to learn: How Much Credit Card Debt is Too Much? [ANSWERED]
It Is Easier to Be Approved for a Secured Card
As mentioned, it is much easier to be approved for a secured card than an unsecured card. Because you make a security deposit, secured cards present less risk to lenders.
Secured Cards Have Lower Limits
Most secured cards will have lower limits than unsecured ones. This comes from the fact that your deposit typically serves as your limit. While some cards may let you deposit a higher amount, it isn't necessarily practical. This means most people with secured cards will end up with limits of just a few hundred dollars.
By contrast, unsecured cards, especially for those with excellent credit scores, can easily be tens of thousands of dollars or more.
You Need a Deposit for Secured Cards
The fact that you need a deposit for secured cards is worth repeating. This means that to get a secured credit card, you have to be able to afford to put money aside and essentially lock it up. You will not have access to this money. This may be impossible depending on your budget.
Secured Cards Rarely Have Benefits
It is also worth noting that it is rare for secured cards to come with benefits, such as earning points, cashback, or airline miles. By contrast, rewards are common on unsecured cards.
Either Type of Card Can Have High Fees and Interest Rates
Whether you get a secured or unsecured card, your fees and interest rates can vary greatly. Both types of cards have options with high fees and options with low fees. Your rates and fees will typically depend on your credit score.
Both Types of Cards Can Report to the Credit Bureaus
As long as you make on-time payments, both types of credit cards can boost your credit score. The key here is that you must pay on time. You also need to confirm that your chosen card reports to all three major credit bureaus.
Secured credit cards require a deposit as collateral, while unsecured cards do not. Unless it is specified as a secured credit card, it is safe to assume that a card is unsecured. Secured credit cards are typically only popular with people with poor or no credit scores.
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Shawn Manaher is a former financial advisor, has founded 5 online businesses, and is a coach, speaker, podcast host, and author. He's been featured on Forbes, The Consults Corner on TAE Radio, The Writing Biz, What's Your Story, and more.