4 Basic Credit Card Types
Credit cards are useful financial resources. Proving that you can use them responsibly is a good way to build your credit score and show lenders that you are a candidate for good credit terms on car loans, mortgages, and other important loans. Some people struggle with credit, though.
Young people have a hard time building credit at first, and others have a hard time rebuilding credit after a financial setback. These groups might not qualify for a traditional credit card, but luckily there are other alternatives. We have highlighted the four basic types of credit cards here. We cover how they work, how much they cost, and how they affect the credit score and credit report.
Unsecured Credit Cards
What makes these cards “unsecured?”
These types of cards are called “unsecured” because they do not require collateral. In other words, you do not have to give a security deposit to open an unsecured credit card.
How do unsecured credit cards work?
- Allow for a revolving balance up to a pre-determined credit limit.
- A portion of the credit limit is used when a purchase is made, and it becomes available again when a payment is made.
- Unsecured cards are the “traditional” credit cards.
What costs are associated with unsecured credit cards?
- Accrue finance charges
- May have membership fees
- Typically charge late fees if payment is not made by the due date
- Typically charge over-limit fees if balance goes over the credit limit
How do unsecured credit cards affect consumers?
Pay history and credit activity on these cards:
- Are reported to the credit reporting agencies
- Will impact the credit score
- May cause an increase or decrease in the credit limit
Secured Credit Cards
What makes these cards “secured?”
These types of cards are called “secured” because they required collateral. By making a security deposit, you secure the card. If you run into trouble and mishandle the card, the creditor’s losses will be limited because they got a deposit from you.
How do secured credit cards work?
- Primarily intended for those without a credit history or who have a troubled history
- Most require a security deposit.
- The credit limit is usually between 50% and 100% of the security deposit.
- Typically require monthly payments
- The security deposit earns interest at about the same rate as a savings account. The security deposit is returned soon after the account is closed.
What costs are associated with secured credit cards?
- May have membership fees and/or application fees. *Note, when choosing a secured credit card, look for creditors who do not charge application fees.
- Accrue finance charges and sometimes charge monthly maintenance fees. *Note, when choosing a secured credit card, be sure to read the “fine print” and understand all terms and conditions. Some secured credit cards have poor terms that will take up a high percentage of the credit limit with monthly fees.
- Can charge late and over-limit fees
How do secured credit cards affect consumers?
- May impact the credit report/score. *Note, when choosing a secured credit card, pick from a creditor who reports to the credit bureaus. Doing so will help you build credit if you use the card responsibly.
- Secured credit cards are seen as stepping stones to unsecured credit cards, which offer better terms and lower fees. Usually, someone with a secured credit card can qualify for an unsecured credit card after a year of responsible credit use.
How do prepaid cards work?
- Funds are loaded onto a card before the card can be used.
- Purchases are withdrawn from the balance.
- Spending limit does not increase until more funds are loaded
- These cards are typically offered at big retailers, like Wal-Mart.
What costs are associated with prepaid cards?
- Do not accrue interest and do not have minimum payments
- Typically have loading fees and could have fees assessed each time they are used
- Re-loading fees are sometimes waived, but stores will likely still charge check-cashing fees.
How do prepaid cards affect consumers?
- Not considered actual credit cards since funds have to be loaded
- Similar to debit cards but not tied to a checking account
- Do not report to the credit reporting agencies
- Due to fees, these cards are not great long-term options. They are best used only when a consumer does not qualify for a traditional credit card or is practicing healthy spending habits before getting a traditional credit card.
How do debit cards work?
- Tied to the checking/savings account of the cardholder
- Purchases and funds used are withdrawn from the balance.
- There is no spending limit – funds must be available in order to use the card.
- If you use more funds than you have available you will either be charged an overdraft fee with your bank (if you are enrolled in overdraft protection service) or your card will be declined.
- Can be used for online purchases and travel reservations
- The issuer may limit cash access or ATM withdrawals.
- May have to carry a minimum account balance
What costs are associated with debit cards?
- Some have fees each time they are used.
- Some have monthly maintenance and service fees. *Note most banks offer ways to avoid monthly fees, such as maintaining a minimum balance.
How do debit cards affect consumers?
- Do not report to the credit reporting agencies as credit cards do
- Choosing a debit card involves choosing a bank (since the card is tied to a checking account).
- When choosing a bank, look for low fees, accessibility, and customer service.