Secured vs. Unsecured Credit Card
- A secured credit card requires the cardholder to make a security deposit, whereas an unsecured credit card doesn't require a deposit.
- A good credit score is not required to be approved for a secured card, but a good credit score will determine your interest rate and other factors for a secured credit card.
- Secured and unsecured credit cards can be a great tool for building a positive credit history and improving your credit score; each has its advantages and disadvantages.
According to the Consumer Financial Protection Bureau, the government agency responsible for protecting consumers' financial credit interests, more than 175 million Americans have a credit card. Although there is a common basis of what a credit card is, there are as many flavors of credit cards as there are credit cardholders. For example, some cards give points toward hotel stays or airline miles with every purchase. Other cards reward spending with cryptocurrency or contributions to a stock market account.
However, one of the biggest differences between credit cards is whether the card is secured or unsecured.
What is a Secured Credit Card?
Secured credit cards were created to enable those with less-than-stellar, limited, or no credit history to obtain a credit card. Although secured cards account for less than one percent of the credit card market, they play a vital role in helping build a positive credit repayment record. Therefore, they serve as an onramp to obtaining an unsecured card.
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The security behind a secured card is cold, hard cash. Your cash, that is. A secured card requires a security deposit, typically in the minimum amount of $200, to the bank that issues you the credit card. The cash deposit will then set the lower bounds of your credit limit.
So how does it work? First, you must apply and be approved by a credit card issuer. Then, after approval, you deposit a set amount of money for the security deposit to back up the card. So, if your deposit was $200, the issuer will provide you with a credit limit of at least $200. Depending on your credit score and history, the limit could possibly be higher.
Benefits of a Secured Credit Card
In addition to a secured card giving you access to the flexibility of plastic in an ever-growing cashless economy, it provides these two other important benefits: a lower cost of credit and an easier approval process.
Credit rating agencies classify FICO scores of 580 to 669 as 'fair' or 'average.' Approximately one-third of all Americans have FICO scores that fall within that range.
Recommended Read: Tips on How To Improve Your Credit Score
At the 'average' score level, unsecured credit cards can come with numerous fees, including a one-time fee to open the account, an annual fee for the open account, and a monthly fee to service the account. These fees can leave you paying $150 or more to open the account in year one and an ongoing $100 or more in years two and beyond to continue the account. And, of course, these costs are before you consider any late payment fees, which also tend to be higher. Secured cards, however, typically have no annual fee, or a relatively low one ($35-$50), and no or a minimal monthly maintenance fee.
Doesn't Require a Good Credit Score
One of the top advantages of a secured credit card is that your FICO score tends not to significantly influence the credit decision. Why? If you miss a monthly payment towards your balance, the card issuer will apply a portion of your security deposit to cover the payment amount due. While it is possible to obtain an unsecured card with less-than-perfect credit, fewer options exist for those with FICO scores of less than 580.
A must if you have a secured credit card is to make sure you never miss a monthly payment. Therefore, once you have built a record of consistently paying your credit card bill on time, you can ask your card issuer if they offer the opportunity for you to "graduate" to an unsecured card. If you are able to "graduate," a typical benefit is refunding your deposit and increasing your credit limit.
Cons of a Secured Credit Card
A secured credit card may be a good option for someone with no or poor credit history. Since your credit score is not a dominant deciding factor for approval of a secured card, a security deposit is required. However, the security deposit can pose a challenge for some who are already struggling to save funds. Additionally, if you default on your credit card, the credit card issuer can take the security deposit that you've posted against the card.
What is an Unsecured Credit Card?
Unsecured credit cards are held by 99% of all credit card holders and are generally referred to simply as "credit cards." Unlike secured cards, an unsecured card does not require a security deposit to back it up. Therefore, the credit card issuer looks closely at your FICO score and other credit history indicators, and repayment ability when deciding on approval or denial of your credit card application.
Pros of an Unsecured Credit Card
The most significant benefit of an unsecured credit card is access to a 30-day revolving line of credit with no collateral requirements. The line of credit can be valuable for many reasons, such as quickly paying in the case of an emergency or unexpected expense arises.
Additionally, unsecured credit cards offer numerous incentives and rewards, such as:
- sign-up bonuses
- travel points
- spending discounts
- cashback on your card; sometimes as much as five percent
- 0% percent interest rates during an introductory period; different cards have different time periods, but the introductory period is usually 15 or 18 months
- 0% percent interest rates offered on balance transfers
- the ability to borrow cash from a credit card in the form of a cash withdrawal
Cons of an Unsecured Credit Card
Although there are many benefits, there are some things you must consider or understand in order not to allow a secured card to make your financial situation worse. Most notably, unsecured cards don't require a deposit, but they typically have higher interest rates and fees.
The interest rate on an unsecured card depends on your credit score. FICO scores deemed 'excellent' by credit rating agencies is a minimum score of 720. A high score usually results in a low-interest rate on your purchases, currently at 13% - 15%. Conversely, a FICO score of some 100 points lower at credit score ranges between 620-630 can result in a credit card interest rate of 25% to 30%.
Reading the fine print before opening a credit card account is highly recommended. The fine print will provide you with the necessary information, such as if or how much is the annual fee. For example, some cards have no annual fee, whereas others can have a fee of upwards of $100. Likewise, fees for late payments and balance transfers can vary across credit cards.
The Money Wrap-Up
There are pros and cons to both secured and unsecured credit cards. However, it is worth noting that each provides a great opportunity to build a positive credit history and raise your credit score, which can pave the way for larger expenditures such as a car loan, home mortgage, or business loan. Accordingly, secured and unsecured cards work best when you make payments on time and keep balances low through careful spending.