Between 70% and 75% of American adults have at least one credit card, according to data from the Federal Reserve. About a quarter of us carry around at least three.
So the odds are, you've got at least one of these products rattling around somewhere. And when used properly, credit cards can be a very good thing. Get a strong rewards program, pay your card off every month and enjoy the benefits.
It's worth knowing how these products work, though. To start off with, let's look at the difference between a secured and an unsecured credit card.
What Is an Unsecured Credit Card?
There are two types of credit cards on the market: secured and unsecured.
Secured Credit Cards
A secured credit card is one backed by collateral on the part of the user. To open one, you typically place a sum of money on deposit with the credit card company and receive a credit limit equal to that amount. (For example, you might give the credit card company $1,000 to get a $1,000 spending limit.)
This deposit secures the credit card. If you fail to make payments, the bank takes the balance out of your deposit instead.
A secured credit card is a tool for building credit. People who have credit scores too low to open an unsecured credit card can still open a secured account because there is no risk to the company, which already has a payment deposited. By making regular payments on this card you can then build your credit score over time.
Unsecured Credit Cards
An unsecured credit card is one that requires no collateral to open. Instead of basing your credit limit on a good-faith deposit, the credit card company will base it on your credit history, income and outstanding debt load. The twist, though, is that since secured cards tend to cater to poorer, more vulnerable consumers, unsecured cards often have better interest rates.
Yes, secured cards have virtually no risk but they are also issued to consumers with virtually no options. It's the old economic principle of "what are you gonna do about it?"
Unsecured cards also offer rewards programs. Secured cards rarely have this perk, their upside being the (expensive) chance to rebuild credit one payment at a time.
With an unsecured credit card the lender has no property or finances to back up their loan. There is only the promise of repayment. This is the most common form of credit card; secured products are relatively unusual in the marketplace.
Credit Cards vs. Other Debt
With no collateral on file, an unsecured credit card is a slightly riskier loan than many other forms of debt. Most forms of common debt, such as a mortgage, an auto loan or a student loan, come with some sort of collateral or guarantee to secure the loan. In the case of an asset-related loan, the lender can seize and sell the property if you don't make payments. In the case of student loans, the government guarantees many of the loans extended under this system.
Credit cards are different. They are used for day-to-day consumer purchases. The lender can't recover the dinner that you bought with it, nor would it be effective to try and recover the money by piecemeal repossession of TVs and sweaters.
This is one of the reasons why credit card interest rates tend to be significantly higher than other forms of debt. The other big reason is that South Dakota has lax usury laws compared to the rest of America. (Thanks to a 1978 Supreme Court decision, your credit card company charges interest based on the laws of its headquarters, not based on the laws of the state in which you live. So credit card companies reincorporated in states like South Dakota, which effectively abolished usury laws in an effort to lure in corporate tax dollars.)
The risk involved to the lender is greater when there is no security attached to the loan. This is also why credit card borrowing limits tend to be relatively low compared to other forms of debt. While a bank will extend credit worth hundreds of thousands of dollars to someone buying a home, most credit cards have spending limits in the five- or even four-figure range.
What Credit Score Do You Need?
The truth is, most credit card companies will find you. Once you have an address registered with just about anyone, it will filter through many different systems and the offers should start arriving in the junk mail. But that's not a great way to choose financial products.
By far the most important part of applying for an unsecured credit card is your credit score. Generally, credit scores break down into the following categories:
• Excellent Credit: Score 750 - 850
At this range you can apply for just about any credit card on the market, such as American Express (AXP) cards and the well-loved Chase (JPM) Sapphire . While the top-tier cards might require a score above 800, in general you can shop generously with these numbers.
• Good Credit: Score 700 - 750
This is a solid credit score that will let you apply for many of the most popular cards on the market. While it won't quite get you the top-tier cards, you can certainly apply for some excellent ones like the Capital One (COF) Venture card. (Don't let the second tier status fool you either. The Venture card is this writer's product of choice due to its excellent travel rewards.)
• Fair Credit: Score 650 - 700
You can still get many starter cards in this category. Few will offer rewards programs, and they might have annual fees, but you can get an unsecured card and continue building your credit score towards one of the better products on the market.
• Less Than Fair Credit: Score 650 and below
You might be able to get a starter card with a score above 600, but by and large anything below 650 will make it difficult to get an unsecured credit card. In this range you may need to consider a secured product to help recover your credit rating. (Don't worry though. Use it for your basic subscriptions, nothing more. Put your Netflix (NFLX) account on this card, set it to autopay and stick it in a desk drawer. That credit score will start climbing before you know it.)
Bottom Line on Unsecured Credit Cards
Compared to a secured product, an unsecured credit card is generally a much better financial option. Most will offer a couple of key benefits, including:
• A higher credit limit than a secured card, giving you both more spending freedom and less credit utilization (which is good for your credit score).
• Rewards programs, which are rare for secured cards and never as good as those offered by unsecured cards.
• Typically lower interest rates, particularly for people with good credit.
• No need to tie up a large sum of cash for the deposit.
Whether getting a card at all is the right financial move for you, that's another story. The old saying holds that credit cards are for people who need time, not money. These days we should really update that to: Credit cards are for people who want rewards, not money.
You should not rely on a credit card for expenses. Even if your needs are as simple as paying a few bills before the end of the month, credit cards are a dangerous way to make ends meet. That said, we understand that sometimes you simply don't have better options. If that's the case, then do your best to pay that balance off quickly so that the interest doesn't run.
Otherwise, pick a credit card if you want the rewards it can offer. If you need it to access cash… it's usually not a good financial move.
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