Secured vs Unsecured Credit

Understand the differences between secured and unsecured credit.

One big distinction between different types of credit is whether the credit line is secured or unsecured. Secured credit refers to any credit line that’s backed by collateral. Unsecured credit refers to any credit line that doesn’t have collateral. This distinction is important because it impacts several aspects of debt repayment:

  1. Secured credit tends to offer lower interest rates, even if you have bad credit
  2. Collateral has a big effect on what happens if you don’t pay what you borrowed back.

How is credit secured?

Secured credit refers to any loan or credit line that requires collateral. When it comes to loans, the property you purchase with the loan is often the collateral used to secure it. So, for instance, your home is the collateral for a mortgage and your car is the collateral for an auto loan. But property that’s purchased with a loan is not the only way to secure a line of credit. If you get a loan at a pawn shop, you generally offer something up as collateral, anything from jewelry to electronics to guns.

There are also secured credit cards. These are credit cards that you can get even with a bad credit score or no credit score. You put down a cash deposit and the creditor extends you a credit line of equivalent value.

Boosting your credit score with a secured credit line.

Good credit is important for your financial stability and long-term success. Unfortunately, if you haven’t used credit before or if you’ve had trouble in the past that has led to a bad credit score, you may encounter some roadblocks as you try to build your way to a better credit score. Those roadblocks usually come in the form of rejections when you apply for credit cards or loans. The credit issuers won’t extend you credit because you don’t have good enough credit to qualify. So it almost seems like a Catch 22 – you need good credit to get credit, but you can’t get the accounts you need to achieve a better score. This is where secured credit cards can give you the edge you need. The information below can help you understand how credit works and how you can use it to strategically work towards the better credit score you want and need. If you have questions or you need to address challenges with debt before you start to rebuild your score, we can help. Call Consolidated Credit today at  to request a confidential debt and credit evaluation from a certified credit counselor, free of charge.

The difference between secured and unsecured credit cards

Keeping your personal data safe from fraud

A secured credit card is different from the traditional unsecured credit lines we usually think of when it comes to credit cards. Having “secured credit” means the debt is backed up by some type of collateral. If you don’t pay back what you borrow, the collateral gets taken to recoup the losses for the creditor. With loans, the collateral for a secured debt is usually the property you’re investing in. So the collateral on a mortgage is the home itself and the collateral on your auto loan is the car. Foreclosure and repossession are the risks of nonpayment when it comes to secured loans. On the other hand, secured credit cards don’t have property attached to the debt. As a result, the “collateral” put down to secure the credit line is usually a cash deposit you make to the creditor.

How secured credit cards work

These are the general steps you can follow to obtain a secured credit card:

  1. Search a credit issuer’s website or a credit card comparison website for “secured credit cards.”
  2. Apply for the card with the best terms and services to fit your needs – make sure to pay close attention to fees and interest rates to make sure you get the card that costs the least amount of money to use.
  3. The credit issuer will request a deposit that can usually be paid directly from your bank account using your bank routing and account numbers.
  4. In most cases the credit line you get approved to use will equal the amount you deposit. In some cases, a few secured credit cards may give you a little extra credit line in addition to the deposit. For instance, you’ll put down $300 but the creditor will extend you a $500 credit line.
  5. Once you have your account, start making purchases strategically – i.e. only charge what you can afford to pay off each pay cycle so you can pay off the balance in-full every month.
  6. As you make payments on time and manage your debt responsibly, the creditor may increase your credit line without any additional deposit, but always follow Step 5 and make sure you can pay off what you borrow every month.
  7. After about 6 months (depending on where you started with your credit score) of on-time payments, you should see an improvement in your credit score – you will either need a credit monitoring service if you want to check or certain credit cards may offer a credit score tracker when you open the account.
  8. Once you have achieved at least a fair credit score, most creditors will begin to offer and approve you for unsecured credit cards that don’t require a deposit.
  9. Even if you start using unsecured credit instead, it may be a good idea to keep this secured account open and use it every so often so you can maintain it as your oldest account maintained in good standing – this is a factor in your credit score and closing the account may decrease your score.
  10. If you choose to close the secured account, the credit issuer will refund your deposit as long as you’ve made all payments on time. If you allow the account to default, you lose your deposit.

Other tips for secured credit cards

While secured credit cards differ depending on the card and credit issuer, the following general rules can help you use the account to your best advantage:

  1. Be careful with annual fees – these can make certain cards more expensive to use on a yearly basis.
  2. Opt for low interest – this way, if you ever have a month where you can’t pay off the balance in full, you don’t end up running up the debt with added interest charges.
  3. Be wary of secured reward cards – in rare cases, you may find a secured credit card with a rewards program included, but whether you’re new to credit or you’ve had trouble in the past, earning rewards while you manage the debt effectively is a more advanced credit strategy. It’s often better left for when you’re more comfortable using credit. Additionally, rewards credit cards tend to have higher interest rates.
  4. Make sure the issuer reports to all three bureaus – this way you ensure you’re building credit effectively with the credit bureaus that maintain the profiles used by lenders.
  5. Make sure the deposit is fully refundable – in most cases, you should be able to pay off your balance and receive your full deposit back.
  6. Opt for credit tracking if it’s available – some issuers offer free credit score tracking or credit monitoring when you open an account. This can give you a big edge as you work to build credit.

How to manage unsecured debt effectively in your budget.

Unsecured debt offers several distinct advantages over its secured counterpart – especially when it comes to open-ended revolving credit lines like credit cards. The only trick comes in knowing how unsecured debt works, what it means for your bottom line, and how to manage it effectively to avoid potential problems that can lead to financial distress.

What does it mean when debt is unsecured?

Unsecured debt refers to any type of debt that is not backed up with collateral. It’s basically a line of credit that gets extended to you in good faith that you will repay what you’ve borrowed. Getting approved for financing that’s unsecured is based on your credit score and overall credit profile. Unsecured debt is the counterpart to secured debt that IS secured by collateral. Essentially a secured debt has collateral that’s specified when you open the line of credit. If you don’t pay what you owe, the collateral is taken to cover the unpaid debt. A mortgage and an auto loan are both secured debts because if you don’t make the payments as scheduled then the lender can take back your home in foreclosure or repossess your car.

The primary benefit of unsecured debt

The most significant benefit of unsecured debt is that you don’t have to worry about your property or assets being taken if you fail to pay back what you owe on time. Falling behind on a credit card bill can be stressful, but that stress is compounded with a car loan if you’re worried about the bank coming to repo your vehicle. By contrast, the only thing that can happen if an unsecured debt goes unpaid is that the creditor can write off the account as a loss (it will be listed as a charge-off) and attempt to collect the amount owed. In a worst case scenario, they can take you to court and sue you to get the money you owe. However, without a court order, your property and assets can’t be taken to repay an unsecured debt. This is why most experts encourage caution when taking out a secured loan like a home equity loan just to pay off your credit cards. Most credit cards are unsecured debts, while a home equity loan is secured using your home as collateral. The problem with this is that once you take out the loan to pay off the credit cards you’ve effectively exchanged unsecured debt for secured. Now if you fail to pay back that loan, you can put your home at risk of foreclosure.

Aren’t all credit cards unsecured?

No. Although the type of cards we traditionally think of when we think of credit cards are unsecured – the kind where you apply for a card, then the creditor offers you a certain credit limit and rate based on your creditworthiness and credit score – there are actually other credit cards called secured credit cards. If you’ve used credit before and have a decent credit profile then your credit cards are likely to be all unsecured. However, if you’ve never used credit before or don’t have a good credit score then you may not be able to get approved for unsecured credit cards. In this case, you apply for a secured credit card. The collateral is a cash deposit you put down. In most cases, the credit limit is equal to the size of the deposit you make, although some creditors will give you a little higher limit as long as you make a deposit of a certain size. Secured credit cards get paid the same way unsecured credit cards get paid. Your monthly payment is based on how much you’ve charged and can vary as your balance goes up and down over time. The only difference is that if you fail to pay the debt back, instead of sending it to a collector after the charge-off the creditor will simply take your deposit and close the account. Secured credit cards are a stepping stone to unsecured credit. If you can’t qualify for an unsecured credit card, consider opening a secured credit card account and using it for at least six months to a year. This will help you build a positive payment history so you can get approved for an unsecured credit card once you’ve had some time to improve your credit score.

Unsecured debt consolidation

The second biggest benefit of unsecured debt is that it can be consolidated if you have multiple unsecured debts that all need to be paid back. Debt consolidation is the process of taking several debts of the same type and rolling them into a single monthly payment at the lowest interest rate possible. Unsecured debts can be consolidated – you can consolidate credit cards, store cards, gas cards and unsecured personal loans into a single monthly payment using one of several debt consolidation methods. Student loan debt is unsecured, too, but it can’t be consolidated with credit card debt. Instead, it can be consolidated separately on its own. One form of debt consolidation for unsecured debt is an unsecured debt consolidation loan. This is a loan that you qualify for based on your credit score that doesn’t require collateral. You get enough money in the loan to pay off all of your unsecured debts like your credit cards, leaving only the loan to pay back. This can be a good form of debt consolidation to use if you have a good credit score to qualify for a low interest rate. A strong selling point of this type of consolidation is that if you get into trouble down the road after you’ve consolidated, a debt consolidation loan can be consolidated again using a debt relief option like a debt management program. The secured versions of a debt consolidation loan like home equity loans should be avoided, however. If you can’t qualify to consolidate with an unsecured loan, you may be better off using a different option to eliminate your debt.