Definition
A secured credit card is backed by a cash deposit from the cardholder which serves as collateral for the line of credit. In contrast, an unsecured credit card does not require a cash deposit but relies instead on the cardholder’s promise to pay and their creditworthiness. Both types of cards extend credit to the cardholder, allowing them to make purchases and either pay off the balance or make monthly payments with interest.
Key Takeaways
- Secured credit cards require a cash deposit that serves as collateral for your account. This deposit is usually equivalent to your credit limit. In case of default, the lender can recover the owed amount from your deposit. Unsecured credit cards, on the other hand, do not require any collateral or security.
- Secured credit cards are often used by individuals with poor or no credit history to build credit, as they present less risk to the lender due to the cash deposit. Unsecured credit cards, however, are typically given to individuals with a good or excellent credit history, as there’s higher risk involved for the lender without collateral.
- The borrowing limit for secured credit cards is usually determined by the deposit amount, whereas for unsecured cards, it’s based on your creditworthiness. Furthermore, secured cards often have higher interest rates and more fees compared to unsecured ones. However, using a secured card responsibly can help improve your credit score over time.
Importance
Understanding the finance term: Secured vs Unsecured Credit Card is crucial because it can significantly impact your credit scores and overall financial health. A secured credit card requires a cash deposit as collateral, making it ideal for individuals looking to build or improve their credit scores.
The credit limit on secured cards is often the amount you’ve deposited. On the other hand, unsecured credit cards do not require a cash deposit upfront.
Card issuers extend credit based on your creditworthiness. Therefore, your credit limit and approval odds largely depend on your credit profile.
Essentially, knowing the difference between these two can help you make more informed decisions about which type of credit card would be most beneficial for your specific financial circumstances.
Explanation
Secured and unsecured credit cards are primarily used for the purpose of building or rebuilding a customer’s credit score, although they function in somewhat differing ways. A secured credit card caters mainly to individuals with poor credit or those with no credit history. It requires an upfront deposit, which serves as collateral and sets the credit limit for the card. The deposited amount is typically equivalent to the credit limit.
This collateral provides a layer of security to the card issuer as they can recover the funds from the deposit should the card holder default on payments. Despite the upfront deposit, like conventional credit cards, purchases made with a secured credit card still need to be paid off in each monthly billing cycle. On the other hand, an unsecured credit card does not require any collateral and is most commonly utilized. These cards are generally issued to individuals with good to excellent credit scores.
The credit limit extended on an unsecured card is based on the cardholder’s creditworthiness, which is determined by their credit score and income level. Cardholders must diligently pay off their balances to avoid interest charges and potential damage to their credit score. Unlike secured cards, card issuers take on more risk with unsecured cards because they don’t have the safety of collateral should the cardholder default on payments. However, issuers mitigate this risk by imposing higher interest rates and penalties.
Examples of Secured vs Unsecured Credit Card
Secured Credit Card: The Discover it® Secured credit card is an example from the real world. To obtain this card, you need to provide a refundable security deposit. The security deposit acts as collateral and is typically equal to your credit limit. This credit card allows you to build credit history with the three major credit bureaus since it reports each month to them.
Unsecured Credit Card: An example of this is the Chase Freedom Flex℠ credit card. It doesn’t require a security deposit, and it has a revolving credit line that you’re able to borrow against. This card provides various rewards on purchases and usually requires the applicant to have a good credit history to be approved.
Secured vs. Unsecured Transition: Capital One Platinum Secured Credit Card is an example of a card that can transition from secured to unsecured. Initially, you are required to make a refundable deposit to secure your line of credit. However, after making your payments on time for a certain period, Capital One reviews your account, and you could potentially be transitioned to an unsecured card and get your deposit back, while still maintaining your credit line.
FAQ: Secured vs Unsecured Credit Cards
What is a Secured Credit Card?
A Secured Credit Card is a type of credit card that requires a cash collateral deposit to open. This deposit is typically equal to the card’s credit limit. This is designed for people with no credit or poor credit, offering a more secure form of credit to the lender.
What is an Unsecured Credit Card?
An Unsecured Credit Card, on the other hand, doesn’t require any collateral. It’s issued based on your creditworthiness. Factors such as your credit score and income will be looked at to determine your credit limit.
Who should apply for a Secured Credit Card?
Those with low or no credit score would benefit from a Secured Credit Card. It offers a way to build or rebuild your credit, provided the issuer reports to the credit reporting agencies.
Who should apply for an Unsecured Credit Card?
Someone with good to excellent credit and a steady income should apply for an Unsecured Credit Card. This type of card may offer rewards and benefits that aren’t typically found with a Secured Credit Card.
What happens if I miss a payment with a Secured Credit Card?
If you miss a payment with a Secured Credit Card, it will negatively affect your credit score. Although the card is secured with a deposit, the issuer will not take out missed payments without consent. You’ll also likely incur late payment fees.
What happens if I miss a payment with an Unsecured Credit Card?
Missing a payment with an Unsecured Credit Card will also negatively affect your credit score. You’ll likely incur late payment fees, and your interest rates may rise as a result of the missed payment.
Related Entrepreneurship Terms
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- Collateral
- Credit limit
- Credit score
- Interest rate
- Default Payment
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Sources for More Information
- Investopedia – An extensive resource for understanding different kinds of financial terms and their implications, including secured and unsecured credit cards.
- Credit Karma – A reputable source for financial advice and explanations, usually focused on credit scores but also includes articles about credit card types.
- NerdWallet – Offers comparisons and understanding articles about all kinds of credit cards, including secured and unsecured.
- Bankrate – A trusted and independent source of various financial information. Their topics range from mortgages to credit cards, including secured and unsecured credit cards.
