Credit cards seem to be a necessity in today’s society — or at least the norm. According to the Federal Reserve, 83% of U.S. adults had at least one credit card in 2020. Some people prefer to use credit cards instead of cash for the convenience and safety that they provide. However, not all credit cards are created equally. There are two main camps: secured vs. unsecured. It’s important to understand what sets them apart so you can make an informed decision based on which one best suits your needs.
A secured credit card is a type of card that requires an upfront security deposit. The amount of the deposit varies depending on your issuer and other factors, but it typically covers your spending limit. For example, if you put $200 down to secure your account, then you’ll only be able to spend up to $200 until the deposit is repaid.
The deposit is held as collateral in case you default on your payments. In other words, if you don’t repay your debt to the credit card issuer, they are able to withhold your security deposit until you do. Secured cards have lower levels of risk because they come with built-in protections that unsecured credit cards don’t offer.
Like regular, unsecured credit cards, secured credit cards also require you to make payments every month. If you carry a balance from month to month, you are still responsible for the principal balance and any interest that accrues. If you do repay your debt and close the account, or upgrade to an unsecured credit card once you are eligible, your security deposit will be refunded.
Unsecured credit cards are what most people think of when they hear the term “credit card.” They require no upfront collateral to get approved for, but unlike secured cards, you typically have a higher credit limit, which is based on factors such as prior payment history and creditworthiness.
Since unsecured cards do not require a deposit as collateral, people with unsecured cards are considered a greater risk. This is why you are typically required to have at least an average credit score in order to be considered for an unsecured card.
Some unsecured credit cards enable people with subpar credit scores to apply and be approved; however, the fees on these accounts tend to be high in order to offset the risk.
Both secured and unsecured cards are reported by credit card issuers to the three major credit bureaus — Equifax, Experian, and TransUnion — and therefore have the potential to impact your credit score, whether positively or negatively.
The major advantage of a secured credit card is that it is accessible to people with no-to-low credit scores. If you have no credit score or bad credit and are rebuilding credit, a secured card could be a prime opportunity. Unsecured credit cards, unfortunately, typically have better terms and rates but are only available to people with credit scores that are average or better.
Another advantage of a secured credit card is that it helps to improve your credit score if you pay your bills on time and maintain a healthy credit utilization. After the security deposit has been repaid, or when you upgrade to an unsecured account after being in good standing with a secured line of credit for several months, your FICO® Score will begin to increase accordingly.
Finally, the security deposit can act as a buffer, as your credit limit is typically no higher than the amount that you initially secure the account with. This helps ensure that you won’t be tempted to spend outside of your means, and instead begin building your credit history in a healthy, managed way.
The main disadvantage of a secured credit card is that you need to make monthly payments on it, which can make it difficult for many people. However, this is no different from a standard credit card. Since the deposit acts as collateral and covers your spending limit, if you don’t have an adequate income or cannot afford to make these payments every month, this type of account might not be right for you.
Another disadvantage is that the interest rates on secured cards are typically higher than those of unsecured credit cards. This is because people with less-than-average or no credit scores have a greater chance of defaulting, which increases risk for card issuers. If you do get a secured credit card, you should try your best to pay off your balance in full each month to avoid accruing interest. If interest does begin to accrue and it’s at a high rate, it can become difficult to overcome.
The best way to use a secured credit card is exactly the same as you would with an unsecured one. Make purchases responsibly and pay off your balance every month in full, or at least by the due date so that interest doesn’t accrue.
If your top priority is building credit and you want to avoid racking up a high balance, use the card for small purchases — like gas and groceries — to make it easier for you to make on-time, manageable payments.
Some cards specify a certain time limit before you are eligible to upgrade to an unsecured card with lower rates and better terms. For instance, an issuer may require you to make on-time payments for five consecutive months in order to qualify for an unsecured credit card. This is helpful, as it gives you an end goal to work toward on your credit journey.
In the meantime, you should keep an eye on your credit score to see if you’re moving the needle at all. Once you’ve seen a decent bump in your credit score, you can also contact your credit card issuer and request to upgrade to an unsecured card.
In general, if you’re looking to make conservative, meaningful moves in your credit-building journey, it can be better to upgrade to an unsecured card with your existing issuer rather than settling your balance and closing out the account. This is because, if you close the account and apply for an unsecured card with another issuer, it will initiate a hard inquiry, one type of credit check, by the new issuer on your credit report. Hard inquiries will appear on your report and hurt your credit score.
The amount of time it takes to build credit with a secured card varies from person to person. However, if you make on-time payments and maintain a good credit utilization, you can begin to see positive changes to your credit score within a few months.
When building your credit with a secured card, remember to:
When you’re contemplating secured vs. unsecured credit cards, the decision is ultimately up to what sort of financial position you’re in. Some people with lower credit scores may not qualify for many of the credit cards with decent rates and terms. In this case, it may be in your best interest to boost your credit score with a secured card before upgrading to an unsecured card.