Secured vs Unsecured Credit Cards
Investing Simple is affiliated with Credit Land.
Ready for some frightening stats about debt? Better sit down before reading the following:
- The average American household carries $137,063 in debt, according to the Federal Reserve’s latest numbers.
- The average U.S. household owes $16,061 in credit card debt.
- A whopping 73 percent of Americans have debt when they die.
- About 68 percent of that is credit card balances.
- After that, in sequential order, are mortgage debt (37 percent); auto loans (25 percent); personal loans (12 percent); and student loans (6 percent).
You may believe these staggering statistics don’t apply to you….because you don’t even have a credit card! But the sad truth is that you will need to have a credit card at some point in your 20s in order to establish a credit score.
How To Qualify For Your First Credit Card
In most cases, you need to be at least 18 to even qualify to apply for a credit card. And if you’re under 21, you will need a co-signer on your credit card application. Federal laws require that people under age 21 must have verifiable income before they can be approved for a credit card without a co-signer. That’s right, you must have income from a paying job, at least part-time, hopefully full-time.
But if you have enough independent income or savings to show that you can, all on your own, pay off debt, you may be able to swing a credit card in your name.
After you turn 21, credit card restrictions aren’t as strict. You will still need to document a steady income, independent of parents or other adults, but you can include any income you have, including part-time jobs, commissions and side hustles.
Credit cards are a way for you to begin building a solid credit history so that you can eventually qualify for a mortgage, a car loan, or even funds to launch a small business.
Credit scores are tracked by banks and all other lenders that approve or turn down mortgage loans, car dealerships financing your next vehicle, insurance companies and even potential landlords.
A healthy credit score means you’re more likely to have approval for a loan, and has an added benefit of boosting your chances of securing an interest rate that doesn’t make you want to throw into the towel financially.
If you’ve never had a credit card or any type of loan in your name, you’re considered high-risk because you have a credit score of 0.
Here’s a quick overview: credit scores generally fall within a range between 300-850. For most adults, their score weighs in between 600 and 750. A score of 700 or above is what most would call good. Score 800 and up, and you’ve earned a gold star and the status of excellent.
Wondering what your credit score is? Check it here!
Just like most things in life, the higher your score, the better. A high score gives lenders confidence that you make good credit decisions and they’re not taking a gigantic risk approving a loan.
The length of time (in years) that you’ve been building credit also works to your advantage. A good goal is to shoot for two to four years of sound credit management to build confidence in lenders and have them give the stamp of approval on your loan application.
The most commonly used type of credit score is known as the FICO score. FICO scoring takes into account five categories of information, each of which is assigned a set percentage.
- Payment history (35% of your score)
- Amounts owed (30%)
- Length of credit history (15%)
- New credit, or when you add another loan to your existing debts, (10%)
- Credit mix, or the diversity of your accounts, such as mortgage, auto loan, etc. (10%)
Your early 20s is really an ideal time for your first credit card application. But despite all the hype around credit cards – the bells and whistles and promises of rock bottom interest rates, a zillion frequent flyer miles, free camping gear and more – it isn’t that easy to be approved.
It’s a Catch 22. You need good credit to get a credit card; but you need a credit card to build a positive credit score.
Without any established credit, it can be difficult to qualify for a credit card. And other common products such as debit and prepaid cards won’t do anything to help you establish credit. Even the Holy Grail of financing – using cash – does ZERO to build a credit history.
One of the best ways to start building a good credit score is to apply for a secured credit card.
What Is A Secured Credit Card
A secured credit card is a type of credit card that is backed by a set money payment used as collateral on the account. You must supply this collateral in advance. Secured credit cards are a good way to go for young adults with limited credit histories.
The deposit made to open the secured credit card account serves as collateral and is generally only used if the cardholder defaults. The collateral makes a secured card different from standard or unsecured cards, which require no such deposit.
In other words, you will need to make payments on your purchases monthly; they do not automatically deduct your deposit/collateral.
Deposits typically start at around $200, but can range as high as $1,000. The credit limit will be set at the amount of the deposit.
For example, a $500 deposit will get you a secured card with a $500 spending limit. They will place your security deposit in an escrow account, which “secures” the card.
Secured credit cards are issued by nearly all of the leading credit card lenders. And yes, these cards still require a standard credit application.
Secured cards are part of a major payment processing network including Visa, Mastercard, American Express, or Discover. Therefore, you can use them just like a standard credit card. It won’t have any indication on it that it’s a secured card. They look exactly the same.
Secured Credit Card Structure And Terms
A secured credit card functions in the same way as a standard credit card. You can use the card anywhere that accepts the card brand, and make purchases up to your card’s maximum credit limit.
Cardholders also receive monthly statements showing their end-of-period balances and the activity on the card during the specified month.
If you go the route of a secured credit card, you need to know it functions like a standard card in that you need to make payments monthly. You will have the option to pay a minimum, or to pay more monthly.
Best practice calls for never paying the minimum! Always pay off the entire bill at the end of the month when it is due. Otherwise, heavy interest rates will kick in.
Secured credit cards are typically used by people who won’t qualify for a traditional, unsecured card. They are a means to an end. The end goal is to build a solid credit history. If used carelessly, and if you default on a payment, the polar opposite will happen: your fledgling score will be marred by delinquency.
The only difference between a secured card and an unsecured card is that secured cards require collateral. The bank will hold onto the deposit, which protects the bank against losses in the event that you cannot repay the balance. However, the purpose of this balance is not to pay down the balance. You are going to make your own on time payments.
You need to make payments on a secured card just like any other credit card. Failing to make payments on time will result in negative marks on your credit report. Collection agencies could also chase after you for any amount you owe in excess of your deposit amount.
People in their 20s usually apply for secured credit cards to improve their credit, but again, keep in mind that your credit score can be damaged if any delinquencies crop up. Typically, secured card lenders will use your deposit as reserve collateral only if you default. But if you miss payments, lenders will report it. This is something you want to avoid at all costs!
If there is a consistent positive payment history on the card, secured card lenders may even increase your credit limit over time. This is something that should be a goal!
It’s also top priority to ensure the secured card lender reports to all three major credit bureaus, helping you build credit for free – as long as balances are always paid on time and in full. More good news: there’s no way to distinguish between a secured and unsecured credit card on your credit report.
How To Find A Good Secured Credit Card
There are many secured credit card products on the market, and a good place to start your search is with your own bank, as you may be able to link a credit card to your checking account, making the billing process much easier.
Of course, you should certainly compare your bank’s card with several others to see which has the most rock bottom fees and interest rates, in addition to any other perks offered.
Many secured credit cards will take a look at your account after a certain amount of time goes by, and they will decide if they can convert an unsecured card and have your deposit returned. As an alternative, once you feel that you’ve established credit, you can apply for a separate unsecured card.
A traditional unsecured card will generally have higher credit limits, but keep in mind, you should curtail your spending to around 30 percent of your credit limit or it will cause a ding on your report. Lenders want to see responsible buying and full, on time payments. They hope not to see you blow out your credit limit in one weekend getaway. It’s always a smart move to use credit for the things you need – clothes, gas, work supplies – rather than things you simply want, such as dinner out on the town.
Tips For Choosing A Credit Card
- What should you look for in a competitive secured card? No annual fees or maintenance fees are an important feature. Many secured cards have fees, and many offered by smaller issuers carry fees that can add up to an astonishing $200 or more per year.
- If you travel frequently, there are some exciting travel-oriented sign-up bonuses, as well as some excellent ongoing perks offered by certain credit cards. These include bonus airline miles, incidental fee reimbursement, free checked baggage, and airport lounge access
- On the other hand, if you don’t travel much, you may be more interested in a credit card that offers cash-back rewards. Some cash-back cards offer extra rewards in specific categories (such as gas stations and grocery stores), while others offer a single cash-back rate.
- Credit card interest can be high — the national average rate is around 15 percent, and many cards charge significantly higher interest than the average. If avoiding interest is a priority to you, there are credit cards with 0 percent introductory Annual Percentage Rates (APR) , and many of these are good for well over a year and have no annual fees.
Like everything else in life, your financial future should not be taken lightly. The steps you take today will impact your life for decades to come. So make informed choices. Do the research and compare what’s out there. Ask questions. Read the small print. Don’t sign anything you don’t understand completely.
And remember, as all our mothers told us, everything in moderation. Be a moderate spender. Plan a budget and stick to it. Save up for the things that are your ideal goals – a new car, a home – and make do with what you have for the interim. Your future financial self will thank you.