Credit cards can be found in nearly every wallet and purse in America, so most small business owners with good credit already have access to that type of financing. But what can you do as an entrepreneur if your credit score isn't the greatest? Should you get a secured credit card? Read on to learn the difference between unsecured and secured credit cards and which one is right for your business's situation.
What is a secured credit card versus an unsecured credit card?
Since their inception in the 1950s, credit cards have been a common payment method for most Americans. In fact, a report by WalletHub using data from the U.S. Census Bureau and Nilson Report found that there were approximately 1.12 billion credit cards in the U.S. as of 2018. By 2023, that number is expected to go up to nearly 1.3 billion.
The report also estimated that the average number of credit cards per U.S. adult was just over three in 2019, with an average total balance of $6,629. And while Experian estimates that the country had approximately $830 billion in credit card debt in 2019, most of that is held through unsecured credit cards.
The difference between a secured and unsecured credit card
On a very basic level, the major difference between these types of cards is that a secured credit card requires some sort of monetary deposit to act as collateral, while an unsecured credit card doesn't. An unsecured card generally has lower interest rates and higher credit limits, while a secured card can serve as a way for people with bad credit to boost their credit scores.
Unsecured credit cards: The common option
If you have a credit card right now, the odds are extremely high that it's unsecured. While the term "unsecured" may sound risky for you as a consumer, it more accurately describes the risk that the card's issuer has taken on, since it acts similarly to an unsecured bank loan and does not require a deposit or other form of collateral.
Without the additional assurance of collateral from you, the terms of an unsecured credit card depend largely on your credit history. If you apply with a good credit score, you'll be more likely to get a higher credit limit, more favorable interest rates and additional perks, like travel miles and cash back. However, if you have a lower credit score and you try to get a credit card, the opposite will be true: You'll receive a smaller credit limit, higher interest rates and little or no additional perks – if you get approved at all. What determines a "good" score and what constitutes a "bad" score vary among the three credit bureaus: Equifax, TransUnion and Experian, though a score in the 700 range is typically considered a good place to start.
Rather than receive collateral to protect their investment, banks and credit card issuers reduce their risk by leveraging their ability to punitively affect your credit file if you regularly miss payments or overcharge your account.
In most instances, delinquent accounts are reported to the credit bureaus, resulting in a decrease in your overall credit score. Such an infraction on your record is considered a major issue to other creditors and remains on your file for years as a red mark for why you should be denied additional credit or loans.
Other courses of action for credit card issuers and delinquent accounts include taking your account to collections, seeking wage garnishments to offset their losses or filing a lawsuit against you.
Secured credit cards: The safe option for creditors
While unsecured credit cards pose a potential risk for card issuers, secured credit cards come with some assurances baked in at the expense of the borrower. Unlike an unsecured credit card, a secured credit card requires the cardholder to make a cash deposit that the credit card company holds as collateral.
That deposit usually sits in the $200 to $300 range and will act as the card's available credit limit. Naturally, a higher deposit will yield a larger credit limit. This deposit is a one-time cost to the borrower that can be refunded once they've either proved their ability to maintain the account in good standing or the account is closed.
Because these cards are backed by collateral, banks and credit card issuers are more likely to approve applications for all kinds of users, including people with no credit or low credit scores. As a result, these cards are generally seen as a safe, yet slow way to build a credit score.
"If you miss a payment on a secured credit card, the money is simply taken out of your security deposit, and the missed payment is not reflected on your credit report," said Michael Broughton, co-founder and CEO of Perch. "If you do carry a balance, interest will be incurred, and the balance will be reported to the bureaus just as it would with an unsecured card. Using a secured credit card can help some build their credit in as little as six months."
Like unsecured credit cards, unpaid bills result in punitive actions that could lower your credit score. A late payment usually comes with an additional fee before getting a higher interest rate tacked on. The longer your payment is past due, the higher your rate will go, until the card is closed and you lose your deposit. Eventually, the account will be sent to collections, at which point your assets could be in jeopardy.
What are the benefits and drawbacks of secured and unsecured credit cards?
Aside from their collateral requirements, unsecured and secured credit cards come with their own inherent benefits and drawbacks. In the case of both cards, you can potentially raise your credit score by diligently making your payments on time, though the other side of that statement is also true. Both cards also give you access to capital that you didn't already have on hand, and both prove your creditworthiness in some way.
And while the two credit card types share some benefits, they also share downsides. For instance, both card types can lead to collections agencies getting involved if your account is unpaid by 120 days, though if that happens, both card types will have negatively impacted your credit score well before then. Additionally, both unsecured and secured credit cards can require a "hard pull" on your credit file when you apply for a card, resulting in a potential hit to your score. This issue is somewhat less likely to happen with secured cards, since they require collateral.
Though unsecured cards generally have lower interest rates, they can still be quite high. As previously mentioned, average rates can be upward of 20%. If you're making just the minimum monthly payment with a high APR, you're likely not making much of a dent in your principal. Likewise, if you're not paying off your card in full each month, a high APR means you'll pay more than the initial cost of whatever you purchased with the card.
Benefits of an unsecured card
As unsecured cards are the most common type of credit card, you're likely already familiar with many of their advantages. Here are some of the pluses of using an unsecured credit card responsibly:
Lower APR. If you have an unsecured credit card, it's likely that you have a decent credit score. As a result, a bank or credit card issuer will feel more comfortable offering you a lower interest rate. Because a lower interest rate means your monthly payments will be smaller, it serves as an incentive to continue using the card. With a lower rate, you can continue to build credit by stretching your limit a little further.
Though unsecured cards' interest rates are generally lower if you have a good credit score, the rates are still often higher than those for most small business or personal bank loans, averaging between 15.53% and 22.76%, U.S. News reported.
Higher credit limits. Again, because you likely have a reasonable credit score, you will likely be trusted with a higher borrowing amount. With an increased credit limit, you instantly gain access to bigger-ticket purchases without fear of getting too close to that limit.
A larger credit limit also affects your overall credit utilization ratio, which is the amount of credit available to the user versus the amount of debt they've incurred. Credit bureaus use your utilization ratio as a metric to see how responsible you are with your credit. A higher percentage of credit used may indicate to lenders that you're a costly and potentially risky borrower.
More card options. As this is the most common type of credit card, your options vary wildly. Credit cards are issued by so many entities, from national and local banks to individual retailers, that it's very likely that you can find an unsecured card that fits your needs.
Rewards for using credit cards. Credit card issuers want borrowers to use their cards, since they make money on the interest and any additional credit card fees. One way they often do that is by offering special rewards to their users. If this is a major selling point for you, then be on the lookout for cards that offer cash back, discounts at certain businesses when using the card or travel mileage that can be redeemed for airfare, among other perks.
More frequent reports to credit bureaus. Credit card usage is just one part of your overall credit score, but it's among the most heavily weighted items. Because your unsecured credit cards represent risk to card issuers, they often report the health of your credit card usage to credit bureaus on a monthly basis. This kind of granular influx of data can help you understand how you're doing and provide you with ways to improve your score. This can often become a double-edged sword, however, since late and missed payments are also reported frequently.
Drawbacks of an unsecured card
Though an unsecured card has many benefits, there are also some negatives to having or trying to obtain one. Here are some of the drawbacks:
Different requirements for each card. Because unsecured cards are ubiquitous, it's increasingly rare to find two credit cards that have the same requirements for approval. Credit score requirements vary from issuer to issuer, so whereas one card may require a 580 credit score for consideration, another may demand a score of 700. This kind of variance means you'll have to do your research about not just your credit score but also what that score needs to be to obtain the card you want.
Added fees. Depending on the type of credit card you use, there may be additional fees baked into your agreement. The most common fee added to an unsecured credit card is an annual "convenience" fee, which can range from $20 to $200. There are enough cards on the market that don't charge an annual fee, so you can avoid this drawback simply by choosing a card without one. Other fees – like late payment fees, balance transfer fees and cash advance fees – should be expected if you meet the requirements for those fees.
Benefits of a secured card
Though a secured card requires you to deposit money as collateral, this type of card has some unique benefits. Here are some of the advantages:
Refundable deposit. As long as you consistently make payments on your account and eventually pay off the balance in full, your deposit is refunded to you. This can help serve as a goal to keep in mind as you're using and paying back the card over time.
Credit building. If you have a bad credit score, it will be nearly impossible to get a decent unsecured credit card without exorbitant interest rates and minuscule credit limits. By requiring collateral of some kind, credit card issuers are more likely to approve individuals with bad credit as a way to help them get out of the hole they've dug themselves into. In some cases, the secured card can eventually get upgraded to an unsecured card. Keep in mind that a secured card only reports payment history, resulting in a slower climb.
Drawbacks of a secured card
Here are some of the downsides to be aware of before getting a secured credit card:
Required deposit. As previously mentioned, to get a secured credit card, you must make a cash deposit of up to $300. If you need a higher credit limit, you may have to add more money to your deposit.
Smaller credit limits. Credit limits for secured cards are usually just the security deposit you put down. As such, your credit utilization ratio will be much tighter than with an unsecured card.
Additional fees. Like unsecured credit cards, secured cards often have a range of additional fees tacked on, such as monthly maintenance fees, annual upkeep fees or incidentals. These are nonrefundable and can add to the overall cost of the card.
Lack of reporting to credit bureaus. Not all secured credit card issuers report these cards to the three bureaus. If you're relying on such a card to help build your credit, it's imperative that you make sure the card issuer reports the account's activity, since not doing so will make your efforts entirely moot.
Which type should you choose?
When deciding which card you should get, consider where you are in your credit score journey. While an unsecured card may be great if you're just looking to maintain or increase your already decent credit score, a secured card could help you get out from under a bad or nonexistent score.
"Both secured and unsecured credit cards have their advantages, but the need for each depends mostly on your credit score and your financial goals," Broughton said. "If you have trouble with qualifying for an unsecured card, a secured card is your best option for credit building through a card."
While most people will want to obtain an unsecured card, a secured card should most often be considered only if you have zero credit history or your credit score is too low for an unsecured card.
When choosing between the two types of cards, the business owner should consider the current marketplace and potential issues they could face, said David Baddely, Director of Scottish Trust Deed. "Having a secured credit card could really help to protect them if something comes along which stops their income – COVID-19 being the perfect example."
Secured vs. unsecured credit card FAQs
How fast does a secured card build credit?
The answer to this question depends on your credit history. A long credit history takes more time to change than a short credit history. If the secured card is your first line of credit, your score will start to improve in about a month. If the history is long, it can take many months – sometimes years – to see a change. In the latter case, resolving outstanding debt will help your credit score recover faster.
What is the difference between a secured card and a prepaid debit card?
Secured cards and prepaid debit cards might sound similar, but they are fundamentally different. With a prepaid debit card, you deposit money to the account or card, and then you can spend it. You are quite literally paying in advance.
The initial payment for a secured card is not an advance payment; it's more like a security deposit. The card issuer holds that money in the event that you are unable to pay off the card, but ultimately, the secured credit card is still a credit card. Whatever money you charge to the card, you will have to pay it to the issuer. When you eventually close or change the account, your deposit is refunded to you.
Another way to look at it is in terms of carried balance. It doesn't matter how long you carry a balance on a prepaid debit card, because that money is already yours. Carrying a balance on a secured credit card is bad, as you will be charged interest on that balance. Carrying the balance can also be bad for your credit score.
How do you transition to an unsecured credit card?
The requirements and limitations tied to this process vary by card issuer. Typically, it is easier to "graduate" to an unsecured card by sticking with the same card issuer. Discover has a tutorial describing its process, and other issuers typically follow a similar pattern.
Once you have used the secured card long enough to demonstrate a pattern of responsible use, you can qualify for an unsecured card. The credit limit, annual fees and APR of that card will still depend on your credit score and credit history, but it is possible to "graduate" while your credit score is still below the standard "good" range. The specific process of graduating is usually just filling out an application.
What credit score do you need to get a credit card?
There is no set credit score required for all cards; card issuers get to make their own rules. In general, they do not issue cards to anyone with "bad" credit. The ranges vary, but a score of 550 to 650 is typically considered low and will disqualify applicants for many cards.
Some cards cater specifically to people with "bad" credit. These cards may have higher interest rates, lower limits or other caveats, but they can be issued regardless of the holder's credit score. The Surge Mastercard is a perfect example.