"[Credit is a system whereby] a person who cannot pay gets another person who cannot pay to guarantee that he can pay."
-- Charles Dickens
As Charles Dickens describes it, credit sounds like a marvelous and miraculous thing. It doesn't quite work like that, though. Most of us have unsecured credit cards, often getting them through being pre-approved and filling out a brief application. Those with bad credit or no credit, though, must spend time building credit records or rebuilding credit scores. Their best option is to get a secured credit card, guaranteed with a deposit they make.
Here's a look at the difference between secured and unsecured credit cards, along with tips on finding good ones.
Secured and unsecured credit cards: Setting the scene
Credit card companies are always looking for more customers. They send out pre-approved offers in the mail by the millions, all year round, and you'll see online offers, too. But they won't give a card to just anyone. After all, it's their money on the line when you use their credit card. They pay for your purchase for you -- and then expect you to pay them back.
Thus, they want to be reasonably sure that you'll pay off your debts. To get a sense of your credit-worthiness, they'll look at your credit score, which reflects your credit history -- how good you are at paying bills on time, how much you owe, and so forth.
If you know your credit score, you might now be wondering just how good it is. Well, basic FICO scores, which are used by about 90% of top lenders, range from 300 to 850. Here's how the folks at FICO rate the scores:
FICO Score Range
Likelihood Borrower Will Become Delinquent
800 and higher
579 and lower
So if you have a poor credit score -- or, not having borrowed money before, you have no credit score at all -- a lender will naturally not be eager to issue you a card -- unless it's a secured one.
Here are the components of a FICO credit score -- it can help to know them if you need to increase your credit score.
Component of Credit Score
Influence on Credit Score
How much you owe
Length of credit history
Other factors such as your credit mix
And lest you not appreciate how much of a difference a good credit score can make in your life, check out the following recent mortgage payments and interest payments for a $200,000 30-year fixed-rate mortgage:
Total Interest Paid
Secured and unsecured credit cards: What's the difference?
Most of us carry unsecured credit cards. They require no deposit from us -- we just charge and then repay. Those who can't get approved for an unsecured card, because of poor credit or no credit, can still get a car -- a secured one, secured by money we deposit into an account that prevents the credit card company from being left in the lurch.
It's a lot like a mortgage or a car loan -- which is secured by a house or a car, as collateral. If you don't keep up with your payments, the lender can claim that property. A personal loan you get from your bank or a friend can be secured or unsecured but is often unsecured. Most credit cards are, likewise, unsecured. There's no collateral protecting the lender. When you rent an apartment, you'll probably pay a security deposit -- that's similar to a secured credit card in that the landlord can keep that deposit if you default on your obligation.
Secured credit cards -- choose and use them wisely
Getting and using a secured credit card may seem like a pain, but it's a good way to build the credit history and credit score that will get you approved for better, unsecured cards. Some secured cards can be converted into unsecured ones at a later date, which can reduce the hassle factor a bit.
However much you deposit into your secured card account will be, effectively, your credit limit. It will sit in your account, letting you charge that much and then awaiting repayment. If you fail to pay back your debt, the card company can just keep the money. If you close the account or get upgraded to an unsecured card, you'll get your deposit back.
When seeking a secured credit card, look for one with no annual fee, or a fee of no more than $50. Try to avoid being charged an application fee and be wary of other fees that might be present.
Be wary of temptations to get an unsecured card that's advertised as approving people with bad credit, because it might charge astronomical interest rates and/or fees. Think twice before solving your need-a-plastic-card problem with a prepaid debit card, too, as that won't serve to build a credit history and won't help you on the path to an unsecured card.
Here's a list of some of the best secured credit cards. Once you have your secured card in hand, be sure to use it responsibly, paying off the bills on time. That will help establish you as a trustworthy borrower and will help you build a good credit history and credit score. It will often take about a year of using a secured card responsibly to be ready for an unsecured card.
Unsecured credit cards -- choose them wisely, too
Once you're able to qualify for an unsecured credit card -- which might be now -- you'll still need to be careful when going about getting one. All cards are not created equal, and some will serve you better than others.
If you're carrying a lot of credit card debt already, you'll need to pay off credit card debt and any other high-interest rate debt as soon as you can. Balance-transfer credit cards and low-interest rate credit cards can be good for that. Great balance-transfer credit cards will charge you no interest for a bunch of months while you work to pay off your debt, while great low-interest rate credit cards can help you spend less on interest payments.
If you're not deep in debt, consider getting a great cash-back credit card or two that will give you cash back or rewards that can be redeemed. Some cash-back credit cards offer a flat percentage back on all purchases. Others have tiers of percentages applying to different expense categories. Still others offer big rewards on purchases in specified spending categories that rotate every few months. Some cards offer a combination of these features.
To make the most of one or more cash-back credit cards, think about your spending habits. For example, if you charge a lot at many different places, you might opt for a general-use cash-back card. You'll find some general cards paying as much as 2% back on everything. There are many great retailer credit cards that give you discounts when you shop with them.
A particularly powerful niche in the reward-card world is the travel card. The best travel credit cards will reward you for your travel-related spending, often including restaurants, and/or will offer discounts on such spending.
Here are some valuable features you might want in any card you choose:
- A generous sign-up bonus: Some credit cards, especially travel-related ones, offer generous bonuses when you sign up for a card. You might need to spend a certain amount in the first few months, but then you might get points or some other reward in exchange.
- No annual fee. Most credit cards don't charge an annual fee. Note, though, that if a card charges, say, $99 per year, and will deliver, say, $200 or more in value, then the fee can be worth it. Even some $500 annual fees might be worth it, but tread carefully on such ground.
- No penalty APR. A penalty APR is what happens when card companies raise your interest rate, often to 25% or more, if you're late paying a bill. Look in a card's fine print to see whether there's a penalty APR, as plenty of cards don't have this feature.
- Low interest rates. If there's a chance you will occasionally be carrying a balance, you should favor cards with a relatively low interest-rate range.
- No foreign transaction fees. Without this feature, if you spend money abroad or with a foreign-based retailer, you'll see currency-exchange-related fees on your statement.
- Other fees: Find out what fees a card will charge you -- such as for paying your bill by phone, getting a cash advance, being late with a payment, exceeding your credit limit, and so on. Think about what services and/or fees might apply to you and what the card might cost you.
Credit cards are not only very convenient when we want to pay for things -- they can also help us establish creditworthiness for other financial needs, such as mortgages or car loans.
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