You may have heard the term “unsecured credit card” and be wondering what it means. Most of the time when people apply for a new credit card, they are getting “unsecured” credit. Unsecured credit cards are the most common type of credit card.
The word “unsecured,” in this case, means that the debt is not secured by collateral — a deposit that can be applied by the lender to the card balance in the event the cardholder defaults on the credit card account.
How Debt Works
The way that debt works is not complicated: lenders want to be repaid. They want to loan money to people who will be able to pay them.
When people are unable to repay their debts; mortgage and auto lenders may need to seize and sell these assets to help recover the money that was lent to the delinquent borrower. Cars may be repossessed and houses may be foreclosed upon.
However, unsecured debt, especially unsecured credit card debt, has no collateral to secure the loan. By definition, this makes unsecured credit cards a riskier proposition for lenders, and credit card users may need to pay higher interest and fees compared to other types of debt.
Here are a few of the key features of unsecured credit cards and how they are different from other types of debt.
How Unsecured Credit Cards Work
Unsecured credit cards require no collateral, so the terms of the debt are based upon the borrower’s credit rating, ability to pay, application information and other factors. Because the debt is unsecured, this type of debt is typically slightly riskier for lenders to issue.
Unlike car loans or mortgage loans, which are “secured” or backed by collateral — a house, a car — that help ensure that the lender can get some of their money back in the event of nonpayment, unsecured credit card debt has no collateral.
Unsecured Credit Card Interest Rates
Credit card borrowers promise to repay the money, and they pay interest on the debt. Credit cards tend to have higher interest rates than car loans or mortgages; in part because credit card debt is riskier for banks.
This is also why unsecured credit card APRs are risk-based and may vary among borrowers — borrowers who have better credit histories are less risky for banks to lend to, and so these borrowers tend to get lower APRs. Payment terms do not vary much.
Alternatives to Unsecured Credit Cards
Although unsecured credit cards are the most common form of credit cards, not everyone can qualify for this type of card.
If you have limited credit history or poor credit, you might want to consider a secured credit card. A secured credit card may give you the ability to borrow only a certain amount of money (starting with as little as a few hundred dollars) that you secure up front by paying a security deposit.
Over time, as you pay your bills and use your new secured credit card responsibly, you may rebuild your credit and get to the point where you’re ready to move on to an unsecured credit card.