With so many different types of credit cards in the market today, it can be difficult to keep all the facts straight. Each credit card presents its own nuances, giving it a competitive edge to appeal to different business owners based on varying needs. Two broad (and key) categories that credit cards, including business credit cards, fall into are “secured” cards and “unsecured” cards.
The main difference between the two is that a secured credit card requires a refundable security deposit when opening an account, while an unsecured card has no such approval requirement. Note: this is not the same as a prepaid card or debit card. If you are deciding between an unsecured or secured credit card, read on for all the information you’ll need to think about.
In short, the security deposit is required to reduce the issuer’s risk. It’s similar to how a landlord will require a security deposit to be used for any damages when a tenant signs a lease. If no damages are found, the renter gets the security deposit back when they move out.
Secured cards are typically a more viable option for businesses that have yet to build a strong business credit history or that have a lower business credit score. Because businesses with limited credit history or bad credit are deemed riskier to lend to, they can get declined when applying for a “traditional” (aka unsecured) credit card. These credit card applications also usually don’t pull FICO or do a credit check as part of the process either, because they generally don’t require personal guarantees.
This is where secured credit cards come into play. With secured credit cards, an issuer is not lending to your business. The cash deposit you hand over to get your credit card covers any risk they might take on to lend to your business. Deposit amounts for business credit cards can start anywhere from $500 to $2,000, and can range up to $100,000 (or even higher).
In case of non-payment by your billing due date, the security deposit is available to the card issuer to cover the amount owed. In other words, the deposit is your backup payment. Usually, the security deposit acts as the entire credit limit on your secured card although policy differs from issuer to issuer. Sometimes, the security deposit is slightly higher than your credit limit.
Some business credit card issuers may automatically give you a higher credit limit if your payments are consistently made on time. Others may upgrade you to an unsecured card with responsible use (and as your creditworthiness increases). However, you cannot choose how much your credit limit increases and need to be careful not to spend beyond your means. Be sure to keep on track with keeping credit utilization ratio low and making your monthly payments (or whatever your billing cycle is) on time.
If you one day decide to close your secured credit card account or upgrade to an unsecured card, the security deposit will be refunded to you once your balance owed is paid off.
Fees and Rates
While not always the case, secured credit cards may charge lower fees and lower interest rates than unsecured cards. They usually have no annual fee. Since lenders are more certain of getting their money back, your credit limit on secured cards may also be higher with better rewards and perks.
That said, secured credit cards may charge cardholders annual fees, activation fees, maintenance fees, and balance inquiry fees among other charges. These charges will be deducted from your deposit and thus, the amount of credit available to you. You’ll have to keep an eye on the terms and conditions to know if this will be the case with a potential secured credit card.
You are more likely to be approved for a secured credit card than an unsecured card, especially if you are a new business and/or have low credit. Since the deposit you place on a secured card funds your credit line, the card issuer is not taking up much risk with you as a borrower. There is less at stake for issuers with secured cards which increases the likelihood of approval.
However, having the funds for a security deposit does not guarantee you automatic approval. There are many situations where your secured card application could be turned down, including insufficient income, or missing application materials.
On the other hand, unsecured credit cards have stricter requirements and tend to be more difficult to get. By extending an unsecured line of credit, the card issuer is taking on a significant amount of risk. In order to avoid or minimize non-payment, the card issuer scrutinizes unsecured card applications more closely. Applicants with higher credit scores are usually preferred although there are many unsecured card options in the market today for businesses of all credit levels.
Building Credit Score
When it comes to building your business credit score, both secured and unsecured will serve that purpose. Credit reports do not distinguish between secured and unsecured cards, and all major credit card companies will report your credit information to credit bureaus. Your business credit score stands to improve from using either card type, as long as you’re a reliable user who makes payments on time.
If you have a poor credit score, secured credit cards can pave the way toward more financial freedom despite being more costly with higher rates and more charges incurred.
Graduating From Secured to Unsecured Cards
Certain secured card issuers offer upgrades to an unsecured card version if you use your card responsibly and make timely payments. You will usually need to exhibit good payment habits for at least 12 to 18 months to qualify for an unsecured card. Bear in mind - this is only possible for cards that have the capability of graduating from secured to unsecured. Once the upgrade happens, your security deposit will be returned to you and your previously secured credit card becomes unsecured. Of course, you can always take the manual route and use a secured credit card to build your credit, which you then use to get an unsecured credit card!
Last Word on Secured vs. Unsecured Credit Cards
As a business owner, you may prefer an unsecured credit card for its better rates, lower fees, and no deposit requirement. However, qualifying for one depends on your business credit history. You don’t have to give up on having a viable credit line just because you have a lower credit score now or have yet to build your credit history. Unsecured credit cards are a great option to give you extra spending room and an opportunity to build your credit score for better financial prospects as you grow.