When people talk about applying for new credit cards, they are usually referring to unsecured credit cards. But what exactly is an unsecured credit card? Let’s dive in to learn more about unsecured credit cards and why they are so useful.
How do unsecured credit cards work?
A credit card allows you to charge expenses against an existing line of credit rather than having to pay them in cash. When you open an unsecured credit card, what you are actually doing is getting a regular credit card – the kind where an issuer sets a spending limit for you based on factors like your income and your credit rating, and you charge expenses against that limit. and pay your bills every month. With an unsecured credit card, you don’t put down any collateral, just like you don’t put down collateral on a personal loan.
What is a secured credit card?
To understand the benefits of unsecured credit cards, it will be helpful to compare them to secured credit cards. A secured credit card is a credit account you open based on a deposit you make that serves as a spending limit.
You can, for example, make a deposit of $ 1,000 to a secured credit card, and that $ 1,000 is the maximum amount you can charge into that account. In this case, the card in question is secured by the deposit you have deposited – which means your deposit is the guarantee. If you charge expenses but don’t pay your bills, your lender – in this case, the credit card company – can access your deposit to get paid, much like mortgage lenders, who provide secured loans. can force the sale. a house to pay off an overdue mortgage.
Now you might be thinking “What’s the benefit of a secured credit card?” And the answer is that, in general, consumers only open secure credit cards when they need help building credit or increasing their credit score.
Imagine you just got your first job and never had any bills in your name. You may not yet have a credit score because there is no data on your payment history. In this case, if you open a secured credit card, take withdrawals from it, and pay off your balance each month, this is recorded as a positive activity on your credit report and payment history.
A secured credit card can also be a good thing to get if you have poor or average credit and want your score to improve. If you want to get one, check out this list of the best secured credit cards.
How can you benefit from an unsecured credit card?
An unsecured credit card allows you to access a line of credit without having to deposit a deposit. Rather, eligibility for this credit card is heavily based on your credit score.
A credit score of 700 or higher usually means that you can easily qualify for an unsecured credit card. But there are many credit card issuers that will approve your unsecured credit card application as long as your score is 600 or higher. To be clear, it’s possible to get an unsecured credit card if your score is lower, but you might not qualify for better deals, like a lower interest rate on your balance or generous rewards.
How are unsecured credit card limits calculated?
When you open a secured credit card, your spending limit is the equivalent of the deposit you put down as security. When you get an unsecured credit card, there is no security deposit on which to base your spending limit. Credit card issuers use other factors to determine how much purchasing power they can give you. These include your:
- Payment history – if you’re used to paying bills on time, credit card companies may be more willing to give you a higher credit limit
- Credit Usage: Your credit usage rate shows how much of your existing credit you’re already using, and the lower the number, the more likely you are to get a generous spending limit.
- Income – the more money you earn, the more likely you are to receive a higher credit limit on an unsecured card
What are the benefits of unsecured credit cards?
Unsecured credit cards give you the ability to open a new account without having to put money down as a deposit, and they usually offer built-in perks like cash back or reward points. Now, some secured credit cards also offer rewards, but these are more common with unsecured credit cards.
In addition, some unsecured credit cards offer signup bonuses. With a signup bonus, you get a certain cash back or points for spending a specific amount of money within a predefined time frame. For example, you might qualify for a credit card offer where you get $ 200 cash back for spending $ 1,000 within three months of opening a new unsecured credit card.
Finally, if you have excellent credit, you may be eligible for a good APR on an unsecured credit card. And in that case, if you need to carry a scale in an emergency, it might not cost you that much.
What are the disadvantages of unsecured credit cards?
With a secured credit card, you are effectively protected against debt because your spending limit is equal to the security deposit you have deposited into your account. Since unsecured credit cards don’t require a deposit and your spending limit is based on your credit score and other factors, you could easily find yourself in a situation where you charge more than you can. allow you to pay in a given month.
When this happens, you may need to carry a credit card balance. This will make you accumulate interest charges which will cost you more. And having too high a credit card balance on all of your cards could cause your credit score to drop, making it more difficult to qualify for other credit cards or loans when you need borrowing options. .
Also, with an unsecured credit card, your credit card’s APR may vary. This could make your payments more difficult to manage if you need to carry a balance.
Does it make sense to use an unsecured credit card?
Unsecured credit cards are extremely common and many consumers use them. If well managed, they can be a useful and practical financial tool. But they can also be a riskier prospect than secured credit cards.
If you want to get an unsecured credit card, make sure you follow these rules:
- Only charge expenses that you can afford to pay when your bills are due (there may be exceptions here for emergencies, but for the most part, try to pay your balance every month in full)
- Never miss a minimum payment, as this will automatically have a negative impact on your credit score
- Regularly check your credit card balance to keep tabs on your spending
- Always read your credit card agreement so that you understand the terms of your card, including your total credit limit, interest rate, and payment schedule.
If you can qualify for an unsecured credit card, there is no reason to limit yourself to a secured card unless you trust yourself to be financially responsible. Make sure you understand how to use credit cards responsibly before moving forward.