What are Secured and Unsecured Credit Cards?

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Definition:

Secured credit cards are credit cards where the borrower must provide collateral (an asset they will forfeit to the lender if they default), while unsecured credit cards have no collateral requirements.

🤔 Understanding secured and unsecured credit cards

When someone opens a secured credit card, he or she must provide a security deposit or collateral, usually equal to his or her credit limit. If the person fails to make their payments, the lender can then take the collateral to cover any losses. Secured credit cards significantly reduce the risk that the lender accepts when offering the card, which usually makes it much easier for people to qualify for them. Many people who want to build credit use secured cards to do so. Unsecured credit cards don’t require a security deposit from the borrower. Because there is no collateral provided, unsecured cards expose lenders to more risk, which tends to make them more difficult to get, though most credit cards on the market are unsecured.

Example

Suppose Joe has poor credit and wants to get a credit card to start building a positive payment history. He applies for a secured credit card and receives an approval, with the condition that he makes a $300 deposit. He gives the card issuer $300 and receives a card with a $300 credit limit.

Once Joe builds a good history of on-time payments, the card issuer will likely return his $300. So, while Joe originally received a secured credit card, he hopes to eventually graduate to an unsecured one (one that does not require a security deposit).

Takeaway

The difference between secured and unsecured credit cards is like the difference between a loan from a pawnshop and a loan from a friend...

If you want to borrow money from a pawnshop, you need to bring something valuable, like collectibles, antiques, or electronics. The pawnshop will typically give you money and promise to return your item when you pay the money back, as long as you follow their terms. But if you ask your friend for a loan, your friend probably won’t ask you to hand over the keys to your car or one of your video games. Instead, they will likely lend you a few dollars without asking you to provide collateral.

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What are secured and unsecured credit cards?

Credit cards are a type of revolving credit account. When you receive a credit card, your lender gives you a credit limit. You can use the credit card to make purchases, up to your credit limit.

When you have a balance owing, you’ll generally receive monthly bills from your card issuer and need to make at least a minimum payment each month. Even if you don’t pay your credit card bill in full, you can usually continue using it to borrow money until you reach your credit limit.

Secured credit cards are a type of credit card that requires collateral, something of value that the lender can use to reduce its lending risk. You give the lender collateral, often in the form of a cash deposit, and the lender gives you a credit card to use.

Unsecured credit cards are credit cards that don’t require collateral from the borrower. Instead, the lender provides the card with no security deposit or collateral. There are more unsecured credit cards in the United States than secured cards.

What is the difference between secured and unsecured credit cards?

The primary difference between secured and unsecured credit cards is that secured credit cards require some form of collateral.

Secured credit cards pose less risk to lenders because people with secured credit cards have to offer something of value to secure their loans.

For example, secure cardholders may offer a cash deposit of $300 that the card issuer holds. In exchange, the lender gives that person a secured credit card with a $300 limit. Typically, the limit is equal to the collateral offered.

If someone with a secured credit card does not pay their bill, the card issuer can take ownership of the collateral the cardholder provided.

When the cardholder closes his or her account, he or she gets the collateral back, as long as they’ve paid back everything they owed.

Unsecured credit cards don’t have any collateral requirements. The card issuers give credit cards to customers and trust them to repay their loans.

Typically, lenders of unsecured cards base credit limits on the cardholders income and credit score.

How do unsecured credit cards work?

When most people think of credit cards, they think of unsecured cards, because banks issue more unsecured cards than secured cards.

When you apply for an unsecured credit card, the lender assesses your application, looking at factors including your credit history, credit score, other existing loans and credit cards, and your annual income and housing expenses. Typically, you need good credit to qualify.

Based on the lender’s assessment of your ability to pay your credit card bills, the lender approves or denies your application. If the lender approves the application, it will send a card to you and decide on a credit limit.

A credit limit is the maximum amount that you can borrow when using the credit card.

When you receive the card, you can use it to make purchases, so long as you don’t spend more than your credit limit allows. Unlike a traditional loan, where you receive a single lump sum, you can use credit cards on a revolving basis (that is, once you pay off part of the loan, that amount is again available to you).

Every so often, typically monthly, your card issuer sends you a bill. The bill generally includes your new balance and the minimum payment that you must make. When you make a payment, it subtracts that amount from your card’s balance, freeing up more of your credit limit and increasing your spending power.

For example, if you have a card with a $1,000 credit limit and an $800 balance, making a $200 payment will reduce your balance to $600. This would give you $400 in total spending power, where before your spending power was $200.

If you don’t pay your full balance, the card issuer usually starts charging interest based on the balance of your card.

How do secured credit cards work?

Secured credit cards work very similarly to unsecured credit cards, with one or two major differences.

When you apply for a secured credit card, the lender may still assess your application based on things like your credit history, credit score, annual income, and housing costs. If the lender believes you can pay a credit card bill, it may decide to approve your application.

Typically, it’s easier for people with bad credit to qualify for a secured credit card than an unsecured credit card because the lender takes on less risk. The reason lenders take less risk when offering secured cards is that borrowers must offer collateral⁠ — something of value the lender can keep if you don’t pay what you owe.

Once a lender approves your secured card application, it will ask for a security deposit. Typically, your credit limit will equal the security deposit you offer. If you give the lender a $300 deposit, your card will likely have a $300 limit. The lender holds on to your deposit while you have the account open.

Just like an unsecured card, you can use the card to make purchases, up to your credit limit. When you have a balance on your card, you’ll receive bills, usually monthly. Each bill outlines your total balance and minimum payment. If you decide not to pay your balance in full, your card issuer will also start charging interest based on your card balance.

If you don’t make your required payments before the due date, the card issuer can take your security deposit to avoid losing money.

Some card issuers return your security deposit after you make a set number of payments and build a solid credit score. Others won’t return your deposit until you close the account.

Why might someone want to get a secured credit card?

The primary reason someone would want to get a secured credit card is that they have trouble qualifying for a traditional unsecured credit card. This can happen to people who have little or no credit history or who have handled credit poorly in the past and damaged their credit score.

Typically, it is far easier to qualify for a secured credit card than an unsecured card. Most lenders only offer credit limits equal to the collateral the cardholder provides, meaning they take on virtually no risk.

Even if the cardholder maxes out his or her card and refuses to make a single payment, the security deposit will cover the entire amount that the borrower spent.

Once someone has a secured credit card, it functions very similarly to an unsecured card. That means that secured card issuers report card activity to the major credit bureaus, companies that track people’s ability to handle credit.

Using a secured card properly can help people build their credit and qualify for traditional loans and unsecured cards.

Do you get your deposit back with a secured credit card?

If you handle your secured credit card properly, you will get your deposit back eventually. If you miss payments or stop making payments, then you will not get your deposit back.

In the majority of cases, card issuers will return your deposit to you when you close the secured credit card. Each card’s terms and conditions document outlines the precise process for getting your money back.

Some card issuers will automatically graduate you to an unsecured card, returning your deposit after you’ve made enough on-time payments and proven your trustworthiness. Other issuers let you transition to an unsecured card, but make you call to request the change.

Before applying for a secured credit card, make sure to read the fine print to learn about the options for getting your deposit back or upgrading to an unsecured card.

Do secured credit cards help improve your credit score?

Yes, secured credit cards can help you improve your credit score, as long as the lenders report to the credit bureaus. Of course, they only improve your score if you use your cards properly.

Improving credit is one of the primary reasons to apply for a secured credit card, especially if you struggle to qualify for unsecured cards or loans.

The best way to improve your credit with a secured credit card is to use it only for necessary expenses and to pay your bill in full every month. This lets you build a history of on-time payments and avoid paying expensive credit card interest.

Secured credit cards can also damage your credit if you use them improperly. Missing a payment on a secured card will damage your credit just like missing a payment on any other loan. Similarly, maxing out your card can drop your credit score.

How fast can you build credit with a secured credit card?

How long it takes to improve your credit with a secured card varies. It is much easier to build credit from having no history than it is to overcome a history of missed payments.

If you have no credit, it can take as little as a few months for credit bureaus to create a report and assign your first credit score.

If your credit report includes many missed or late payments, it can take much longer to improve your credit score, especially if the missed payments happened recently. It will likely take months to a year of proper secured card use to start rebuilding your credit.

Late payments stay on your report for seven years, but their impact on your score decreases as time passes.

Can you be denied a secured credit card?

Lenders can deny applications for any type of loan, including secured credit cards. While they’re easier to qualify for than unsecured cards, nothing is a sure thing, and you might have trouble opening a secured card if your credit score is incredibly low.

If a lender denies your application for any type of loan, you have a legal right to know why the lender denied your application.

If you ask, the card issuer has to explain its reasoning and provide a copy of your credit report if it used information on that report to deny your application. This can give you hints as to what you need to do before submitting another application.

What are the pros and cons of secured credit cards?

The greatest advantage of secured credit cards is that it is much easier to qualify for one than it is to qualify for an unsecured card. Because you offer collateral, typically equal to your credit limit, card issuers take on almost no risk by offering secured cards.

This makes secured credit cards a great way for people with poor or no credit to start building a credit history.

A drawback of secured credit cards is that you must offer a security deposit when you open the account. Typically, the deposit can range from $300 to $500 or more. That means that you need to have some cash on hand to be able to open an account.

Secured credit cards also tend to have higher fees than unsecured cards. Many have application fees, annual fees, and high interest rates, which can make them expensive to use.

Secured credit cards also tend to lack the perks and rewards, like cash back, that unsecured cards often have.

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