How to Use Unsecured Credit to Build Credit
If your credit is poor you may struggle to qualify for unsecured cards and loans, and if you don’t have access to unsecured credit, it’s hard to rebuild your credit score.
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It’s a Catch 22—a cycle of persistent and seemingly inescapable debt that millions of Americans find themselves in. But all is not lost, there are a number of ways you can improve your credit using credit cards, even if your credit report is so damaged that you’re being rejected for every new loan and credit card you apply for.
Difference Between Secured Credit and Unsecured Credit
There are many different types of debt once you get into the specifics, from revolving credit to consolidation loans and more. But all of these debts fall into one of two categories: Secured and Unsecured.
In simple terms, secured debt is “secured” against an asset, while unsecured is not. A mortgage, for instance, is secured against a house, while a car loan is secured against a car, but many personal loans and credit cards are not.
Each option has its own pros and cons but the biggest are:
- Secured debts can result in repossession but offer good rates.
- Unsecured debts rarely result in repossession but offer high rates.
Some debts are available only as secured and some only as unsecured. Credit cards, however, are the exception as you can get both an unsecured card and a secured card.
What is a Secured Credit Card?
A secured credit card is a credit card that’s “secured” against a cash deposit, known as a security deposit. Unlike a home equity line of credit, which offers a large line of revolving credit secured against your home, a secured card gives you a small sum you can use to build your credit.
A secured credit card generally offers very favorable rates and all providers report activity to credit bureaus. If you meet your monthly payments, you’ll have a new account with a clean credit history and this will gradually improve your credit score.
Once you have used this secured card for a few months, you may be offered an unsecured one with a higher credit limit and more preferable terms. Alternatively, you can just keep using the secured card to build your credit with minimal risk and temptation.
When you find a suitable secured credit card, you need to apply by inputting a few basic details about yourself. The provider will then ask for a refundable security deposit (often in lieu of a credit check) and the credit limit will be fixed to the amount of the security deposit.
In every other way, a secured card works just like an unsecured card. You can think of it like a debit card or prepaid card, in that you add money to it and then use it to make purchases online and offline. You pay off your balance every month and gradually improve your credit score.
If you fail to make those payments, your provider will simply use the deposit amount to cover their losses. This security deposit negates their risk, which is why you don’t need a solid credit report to get a secured card.
What is an Unsecured Credit Card?
Unlike a secured card, an unsecured card does not require a refundable deposit. This increases the risk on behalf of the creditor, so they are much more demanding of the borrower.
With an unsecured card, everything you spend during the course of a month will form a balance that you need to repay. If you do not, then the balance will roll over and start generating interest. A minimum payment will then be calculated, often between 2% and 5% of the total balance, and this needs to be paid every month to avoid late/missed payments and derogatory marks.
On average, an unsecured credit card will charge an annual percentage rate of 17% to 20%, which is much higher than the rates charged for most loans and all secured debts. This leads many to state that unsecured credit cards are a con designed to fleece unsuspecting borrowers.
However, if you only spend what you can afford and clear your balance in full every month, then an unsecured credit card can be a perfectly convenient and secure way to make purchases. Only when you start spending more than you can afford to repay do these cards become problematic.
What are the Benefits of Unsecured Over Secured?
An unsecured credit card offers a much higher limit. A secured card rarely ventures above the $500 mark and the majority of lenders offer just $200. These cards are tied to your deposit, after all, and their main purpose is to help you improve your credit score.
An unsecured credit card is there to be used, to make purchases as needed and to generate a balance. The limit, therefore, is often in the thousands or tens of thousands, although it will all depend on your income and your credit history. An unsecured card also provides more options with regards to balance transfers and rewards. Some secured cards do have rewards schemes, but these are limited to just 1% or 2% cash back, which isn’t great for a card with a monthly balance of just $50 to $100.
Unsecured cards also have strong security measures and fraud protection. If your details are stolen or your card is used without your permission, there’s a good chance you’ll be able to recover that money.
Finally, if the worst-case scenario happens and you can no longer afford to repay your debts, you stand to lose more with a secured card than you do with an unsecured card. With the former, they’ll just take your deposit and you won’t get it back. With the latter, they may sell the account to a collection agency, at which point you can offer a settlement sum or simply wait for the statute of limitations to pass.
We would never recommend waiting for the debt to expire as this can do some serious damage to your credit report and the creditor or debt collector can always take you to court and file a judgment. At that point, the debt essentially becomes secured and the court may garnish your wages.
However, it’s worth noting that unsecured debts like this often provide creditors with very few options if the debtor decides to ignore their obligations and doesn’t care about the implications.
How to Qualify for Unsecured Credit
The first step to qualifying for unsecured credit is for the borrower is to get a pre-approved credit card. This means the creditor has performed a soft inquiry to determine if your credit score is high enough and your credit history is strong enough.
The lender will use the information contained within an applicant’s credit report, in addition to their preferences, to set a credit limit and annual percentage rate. The lower your credit score is, the higher your interest rate will be and the lower your limit will be. The next step is to complete the application process and open an account, which will initiate a hard inquiry and have a slightly negative impact on your credit score.
What Credit Score is Needed?
There is no industry-standard minimum credit score for getting a credit card. It all depends on the creditor and the borrower. For example, you will struggle to get an unsecured card if you have a credit score of less than 500 and don’t have a history with the issuer. However, if you have had a bank account with the issuer for a number of years, they will probably offer you a credit card.
But even then, you will still need a good credit score to get a respectable interest rate.
The best cards are offered to those with credit scores in the high 600s and above. With a credit score below 600, you’ll struggle to find anything with a decent rate and for a score above 800, you’re in control and should only accept the best rates and terms.
Your income will also play a big role. Having an immaculate credit score isn’t enough to qualify for a premium credit card, for instance. You’ll also need to prove that you’re making and spending a lot of money.
Easiest Unsecured Cards to Get Approved For
The easiest cards to get approved for are the ones with the least stringent checks and criteria, which generally means they are offered to borrowers with poor credit and have very high-interest rates. If this is the position you find yourself in, take a look at the following credit card offers:
- Credit One Bank Unsecured with Cash Back: You can get 1% cash back on all eligible purchases made with this card. The annual fee varies and goes as high as $99, but cash back cards are rare for low credit score borrowers so it’s worth considering. Interest rates vary from between 19% and 25% and it’s aimed at credit scores ranging from 300 to 500.
- Indigo Platinum MasterCard: There is a possible annual fee of up to $99 (varies depending on applicant) and no cash back offers or rewards, however, this card accepts applicants that have previously filed for bankruptcy and offers online account management and fraud protection.
- Milestone Gold MasterCard: The APR for this card is fixed at 24.90% and there are no rewards. However, the application is quick and easy, previous bankruptcy filings are not an issue and there is an online account. You can also choose from a number of card designs.
Which Cards Have Guaranteed Approval?
“Guaranteed approval” credit cards are often offered to borrowers with bad credit. Credit card companies run soft credit checks without your permission (perfectly legal) and then send you these offers in the mail. They sound tempting, but that’s the whole point, and in reality, they are not as good as they sound and the process of applying is not as straightforward.
All credit card companies have some basic requirements that need to be met before the application can be finalized. They are unsecured credit cards, after all, which means the lender has no guarantee that you’ll make the repayments every month. The last thing they want to do is start throwing around huge credit limits and then simply hope their customers will cover the monthly payments.
Always pay close attention to the requirements and if these are not displayed clearly anywhere, check the small print. In most cases, you shouldn’t have an issue as they are designed for individuals with bad credit and if you received an offer there’s a good chance they have already run some preliminary checks. However, that’s still not a guarantee.
You also need to be aware that these companies will run a hard credit check if you apply and this can reduce your credit score by up to 5 points.
Finally, pay close attention to the interest rate, annual fee, and penalty fees, the latter of which spans everything from a late payment fee to a cash advance fee.
How Can Unsecured Credit Help you to Build Your Credit Rating?
Your score will take a hit when you open a new credit account. This is true regardless of the credit limit or the type of account. However, the impact is marginal at best, it diminishes with every passing month and should be non-existent after 12 months.
From here, the account will start providing numerous benefits. The main benefit concerns the Payment History aspect of your credit score, which accounts for 35% of your total FICO Score.
The only way to improve your Payment history is to keep making payments on time every month and to ensure there are no late or missed payments. These can have a massively negative effect on your score but if you keep paying on time there’s no reason you can’t build a good credit score.
A new credit card can also impact your credit utilization, which accounts for a further 30% of your credit score. Credit utilization looks at your total available credit (such as a credit limit) and compares this to your total used credit (such as the balance on that credit limit). The greater the difference between the two, the higher this aspect of your score will be and the better your FICO score will be.
A new credit card with a relatively high credit limit will boost your credit utilization, and providing you don’t max it out, it should stay that way.
There are a couple of other ways that a new card can help. These don’t have as much of an impact, but they’re worth noting, nonetheless. The first concerns the age of your accounts. Credit scoring systems calculate the average age of all accounts and this impacts your score—the older they are, the better, which means this category will improve the longer you keep your card.
Finally, your score factors variety into the equation. This will reduce your score if you have nothing but credit cards on your card and you apply for another one, but if it’s your first card and you have other forms of credit and debt, it could boost your score by up to 10%.
Best Ways to Use Unsecured Credit to Build Your Credit
There are a few tips and tricks you can utilize to stay on the right track with your credit card. You’re holding something very powerful in your hands, something that could make or break your credit score—use it carefully.
Credit Card Tip 1: Only Spend What You Have
A credit card should be treated more like a prepaid card—something you use as a convenient way to spend cash and not something you use to spend money you don’t have. Many users see a credit card as easy money, something they can spend now and then worry about later. It’s hard to get out of that habit but it’s essential if you want to maintain good credit.
Only spend what you have right now or are 100% certain you will have in the future. It’s also important to keep track of every penny that you spend and to be realistic about your purchases. Don’t flippantly dismiss that nagging voice in the back of your mind by insisting you’ll find a way to cover the cost. Unless you actually have a way to cover it, you shouldn’t be buying it.
Credit Card Tip 2: Build an Emergency Fund
We often lie to ourselves and live in denial when it comes to money. We tell ourselves that we can’t spare a single dime at the end of the month, even though we know that’s simply not the case, or rather, it wouldn’t be the case, if we made a few small sacrifices.
For instance, the average US wage is around $4000 a month. This is the median average, so it’s greatly inflated by high earners and not representative of the “average” citizen, but we can use it as an example, nonetheless.
The average monthly mortgage payment is $1,000 and once we add the average payments for student loans, credit cards, car loans, and personal loans, we arrive at an additional $900 to $1100. Let’s assume that an individual makes $4,000 and has all of these debts for a total of $2,000 a month. Once food, utilities, and other essentials are added, this increases to $3,000.
That leaves $1,000—and for the average American, that money goes on eating out and buying unnecessary items. Around 10% of the population also wastes money on lottery tickets, casino gambling, drinking, and cigarettes.
That’s a lot of money to waste on things you don’t need. Instead, put that money into a savings account and keep it as an emergency fund. A few sacrifices are all it takes to unlock several hundred dollars of savings a month. If you save just $300 a month for 2 years, that’s $7,200 in cash that you wouldn’t have otherwise had. It’s money you can use to protect yourself in an emergency, covering a credit card balance or repaying an entire debt when you’re struggling at work.
If you can afford to drink, smoke, gamble, eat out every week or buy unnecessary items, then you can afford to save for your future.
Credit Card Tip 3: Don’t Get Too Confident
The vast majority of credit card users pay off their balances in full for the first few months or years. At this point, it’s easy to wonder what all the fuss is about and to question how so many people accumulate credit card balances. But it’s much easier than you might think.
As an example, let’s imagine that you’re a big earner and a big spender. You earn $10,000 a month and you spend $5,000 on your credit card, which has a $20,000 limit. Every month you accumulate and then clear that balance and because you still have plenty of money to cover bills and other debts, you are 100% confident in your ability to repay.
But then you decide to take the family on vacation, to splash out on a big family Thanksgiving and an even bigger Christmas. You’re stretched to your limits but you’re still making those repayments. Then, you lose your job, get demoted or, if you’re self-employed, suffer a dry spell.
All of a sudden, you’re spending money you can’t afford and have no choice but to let that balance tick over. You tell yourself that you’ll cover it next month when things get easier. But your income struggles the next month as well and in month 3, you no longer have a balance of $5,000 to clear, you now have a maxed-out credit card with a limit that is twice what you earn during a good month.
This has happened to millions of Americans and will happen to millions more. That’s why it’s important to plan ahead, create an emergency fund, and never get too confident in your ability to repay your credit card balance.
Credit Card Tip 4: Move Around
If you’re just getting started and are building a credit score from scratch, then after a few years you may want to look at some other credit card offers. Chances are, you have a credit card with a high-interest rate, no rewards, and unfavorable terms. By waiting until you build a strong credit score and then looking elsewhere, you can get something that offers more favorable terms.
If you’re repaying the balance in full every month then the interest rate won’t make much of a difference. However, it’s best to stay on the low side just in case you ever need it and it’s always beneficial to secure a credit card with a good rewards program. It could save you hundreds of dollars over the year.
Opening a new card will reduce your credit score somewhat, but if you have a solid payment history the impact should be minimal.
Credit Card Tip 5: Try a Balance Transfer
If you have multiple credit cards and they all have balances, look into a balance transfer. A balance transfer card is a type of credit card that allows you to move all your current balances onto a new card with a high limit.
You’ll benefit from an extended 0% APR period and in that time, you can gradually repay your debt, with more of your money going towards the principal than the interest. Balance transfer cards have high-interest rates when the introductory period ends and there is also a balance transfer fee. However, if you keep meeting your minimum payments, you’ll have cleared a substantial portion of your debt when the intro period ends.
Credit Card Tip 6: Do Your Research
Finally, always do your research when looking for a new credit card, being sure to research the card and the provider. The same applies to any debt relief schemes that you undertake to consolidate or clear credit card debt.
Options like debt settlement, consolidation, balance transfers, and debt management are all great and these industries are filled with reputable companies. However, there are also companies whose sole goal is to steal your money and exploit your desperation.
Take a look at NMLS Consumer to find reputable companies in your chosen sector.
Summary: Use it Wisely
Whether you have a high-limit unsecured credit card, a business credit card or a balance transfer card, it’s important to use it carefully, understand the terms and penalties, and make it your priority to meet those monthly payments.
If it’s your first card and you’re not confident in your ability to make those monthly payments, then consider a secured credit card instead. As discussed above, a secured credit card provides all the same security and convenience, but without the risk.