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Most people are probably not aware that credit cards, as we usually think of them, are unsecured credit cards. Unsecured credit cards are simply credit cards that do not require a security deposit. For those with no credit or bad credit, they might be required to provide a security deposit to the credit card company. Providing this secured collateral is usually a condition of approval for a secured credit card.
On the other hand, if you have good credit and/or a stable job that you’ve been at for a reasonable amount of time, you might simply fill out an application for an unsecured credit card. After a review of your application and a credit check is made, the credit card issuer will notify you if you have been approved or not.
If approved, you will receive a credit card with a credit limit as set by the credit card company, based upon the details of your application, as well as your credit score and credit history.
Credit Cards and How they Work
A credit card is a loan with a maximum credit limit provided by a credit card company, typically a bank. This limit determines the amount of money available for making purchases. Staying within this limit is important because exceeding it is not allowed.
If you use up all the available credit, you will need to pay down the balance before making additional purchases. The amount you pay down becomes the new available credit. It's important to remember that, in addition to repaying the amount spent, you will also need to pay interest.
Credit Card Interest
Credit cards calculate interest by using your average daily balance (the average balance on your credit card in a given billing cycle). If your APR(annual percentage rate) is 12%, 12 will be divided by 365 (the number of days in a year) and multiplied by the average daily balance to determine how much interest you will pay for that month.
Unsecured vs Secured Credit Cards
Whether or not you get a secured or unsecured type of credit card will really depend on if you have a good credit score. If you have never had a credit card, you have no credit history and likely no credit score. If you have had a credit card, loan payment or other credit extended to you in the past and have missed payments, made late payments, or defaulted on a debt, you likely have a poor credit rating.
Your credit score, which takes into account your credit history (or lack thereof) and spending behavior will typically determine if you are eligible or not for an unsecured credit card. If not, you will need to provide a security deposit and get a secured credit card.
Determining which Credit Card to Get
It’s important to understand your credit before shopping around for a credit card. You can obtain free copy of your credit report at annualcreditreport.com. Here you will see your credit score and credit history. Carefully review this report and ensure there are no errors or omissions that might negatively impact your credit score. If you find errors, you can contact the credit bureaus directly to correct the issue.
Once you understand your credit profile, you will know if you are in need of a secured or unsecured credit card. You don’t want to apply for a credit card without knowing your credit history first. The credit card company will check your credit and multiple credit checks can negatively impact your credit score. If your score is not very high to begin with, you certainly don’t want lose any valuable points.
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Who Qualifies for Unsecured Credit Cards
Credit card companies want assurances that any money lent to you with a credit card will be paid back on time. They want to know that you are responsible enough to make the minimum monthly payment each month, if not more than the minimum monthly payment. Know, that you are more than welcome to pay off your credit balance each month, especially if you want avoid paying interest charges.
Credit card companies look for people who will spend responsibly and not overextend themselves financially. Your credit score is a strong indicator of what type of person you are as it pertains to your spending habits and general behavior concerning debt. Those with a good score 670 or more have the best chances for approval of an unsecured credit card.
How Unsecured Credit Cards Work
Unsecured credit cards work like a loan with a credit line. The credit card company will give you a card limit (the maximum amount you can spend). With your credit card you can make purchases up to the card limit. If you spend all the money allotted to you, you cannot spend any more until you pay the balance down.
For example, if you have a limit of $500 and you spend $490, you only have $10 available to you until you make a payment. If you pay $100, but were charged $5 in interest, your available credit will now be the difference between your payment and the interest charged, plus any available credit you still had. In this instance that would be $95+$10 or $105.
This cycle continues as long as you have the card and its in good standing. Should you demonstrate responsible spending habits and make consistent on-time payments over a period of time, you may be able to ask for a credit increase and get approved for it.
Advantages of Unsecured Credit Cards
The primary advantage of an unsecured credit card is not having to provide a security deposit. The credit limits on unsecured credit cards can also be much higher. There are even some elite credit cards that have no limit (mind you most people don’t qualify for these). However, just because you can, doesn’t mean you should, it’s not recommended to use all the credit available to you. Credit monitoring bureaus also measure something called credit utilization.
Credit utilization is the percentage of money you spend versus the amount of money available to you. They like to see a relatively low credit utilization rate of 30% on average. That means if you have $1,000 available to you, ideally you will not use more than $300 at any given time.
In addition to no security deposit and higher limits, credit card companies typically compete for customers with good credit (people who will qualify for unsecured cards). This competition leads to competitive interest rates (sometimes they offer zero interest introductory rates for a given period of time for new users), benefits such as cashback for purchases, no annual fees, credit monitoring ect.
If you qualify for an unsecured credit card, shop around. There are quite a few credit card companies offering a large variety of cards with all kinds of benefits. Seek out the one that suits you best and that you will benefit from the most and go with that one.