Secured vs unsecured credit cards: What’s the difference?
If you had to guess, you’d probably wager that a so-called "secured " credit card is better than an “unsecured” one.
And you would probably also assume an unsecured card is susceptible to fraud. Doesn't it practically say as much in the name?
But what if you were told people prefer unsecured cards?
Keep reading to understand the difference between secured and unsecured credit cards—and which one suits you best.
What is an unsecured credit card?
An unsecured credit card requires no collateral or security deposit for approval. It has nothing to do with the safety of the card itself. If you’ve had a credit card in the past, odds are it was unsecured.
Think of it this way: When an issuer provides unsecured credit, it’s like lending you money. But because lending entails risk, they want to ensure a good chance of repayment.
To help them avoid risk, the credit card issuer will check your credit. The better it is, the more likely you are to qualify for an unsecured card (and, for that matter, a higher credit limit).
Issuers typically assess the following when determining creditworthiness:
- Credit score: A credit score is based on your past credit history and is the most critical factor in deciding your creditworthiness. Lower scores suggest a borrower with higher risk, while higher scores imply the opposite.
- Credit report: A credit report is a detailed record of your credit history. Credit reports include the amounts and type of credit you’ve accessed, your credit utilization ratio (the amount of credit used compared to the amount you have available), as well as other important details.
- Debt: Issuers want to know if you have any outstanding debts. Higher existing debt levels can harm your eligibility.
- Income: All else equal, the higher and more stable your income, the better.
- Debt-to-income ratio: Higher debt levels relative to income imply a riskier borrower.
- Type of credit used: A mix of credit types is often viewed favorably. It can signal to issuers that you can responsibly manage numerous types of credit, like car payments, student loans, and a mortgage.
- Recent credit inquiries: All else equal, the more inquiries, the greater the red flag. Frequently applying for new credit can indicate to the issuer that you’re facing financial troubles.
- Payment history: Timely past payments over a long period are viewed favorably.
After reviewing all this information, the issuer will decide whether or not to approve you for an unsecured credit card. The information also factors in what kind of credit limit they offer you.
What is a secured credit card?
As you might have guessed, a secured credit card is intended for those with bad credit or no credit history. Because issuers are concerned about the holder's repayment ability, they require an upfront deposit. Often, this deposit is equal to the credit card limit.
How does a secure credit card work?
- After being approved for a secured credit card, you provide the issuer a deposit, for example $500.
- The issuer provides you with a credit card with a limit matching the deposit amount (i.e., $500).
- This credit card can now be used like any other, from purchasing groceries to paying for streaming subscriptions.
Secured vs. unsecured credit cards: which is the better option?
Secured and unsecured credit cards may be similar, but they’re not the same.
|Secured Credit Card
|Unsecured Credit Card
|Yes, an upfront security deposit or collateral is required.
|No deposit is required.
|Higher APR than unsecured cards.
|Lower APR than secured cards.
|Higher fees than unsecured cards.
|Lower fees than secured cards.
|Usually, a lower credit limit equivalent to the deposit.
|Often a higher credit limit than secured cards.
|Lower requirements than unsecured cards. Limits are typically determined by the deposit you make.
|Higher requirements, based on your creditworthiness.
Unless you’re struggling financially, unsecured credit cards are the better option for most people.
The primary purpose of a secured card
You may be wondering what the benefit of a secured credit card is? After all, if you’re depositing $500 and only have access to $500 of credit… how does this differ from simply using a checking account?
Secured cards exist primarily to allow individuals to build (or, in many cases, rebuild) their credit.
Someone might not qualify for an unsecured credit card, but they could be eligible for a secured card. By using the secured card responsibly, they can build a healthy credit history and eventually become eligible for an unsecured card.
6-step action plan to build credit with a secured credit card and land an unsecured one
The good news, even people with bad credit can follow this action plan to improve their creditworthiness.
The bad news, it can take time.
Don’t rush the process. Issuers are looking for a healthy credit history. The longer you use a credit card responsibly, the better.
- Apply for a secure credit card: The first step is to apply for a secured credit card. Choose an issuer that reports to the three primary credit bureaus (Experian, TransUnion, and Equifax). This ensures you’re building a history with widely used bureaus.
- Deposit: Provide the issuer with the required deposit. Unless it’s used to cover lapsed payments, the deposit will eventually be refunded once the card is closed.
- Shop responsibility: Now that you have an unsecured credit card, use it responsibly. Don’t just pay the minimum amount; aim to pay off the entire balance each month. Also, limit how much of your available credit you use. Keeping your credit utilization ratio below 30% can help improve your score. For example, if you have a limit of $1,500, keep the outstanding balance below $500 each month.
- Monitor your credit: You can access a free credit report from the major credit bureaus once a year. Analyze the reports for any errors that might be harming your score. Over time, your score should be trending up. Otherwise, determine whether further action is needed (i.e., lowering your credit utilization rate further).
- Apply for an unsecured credit card: After building up your credit for at least one year, consider applying for an unsecured card. If your credit has improved sufficiently, you might be eligible. In some cases, issuers will automatically review your status, upgrading you to an unsecured card once you meet the minimum requirements.
- Obtain an unsecured card: Transition to an unsecured credit card and obtain your deposit from the issuer of the secured card.
It doesn’t stop there. Just because you’ve qualified for an unsecured credit card doesn’t mean your work is done.
In the future, you may need approval for a higher balance or another loan, like a mortgage. So it's a good idea to continue strengthening your score.