Opening a credit card is a very serious financial decision. As with all financial decisions, it’s not a good idea to fly into this situation blindly. Instead, it’s helpful to weigh out the options to determine whether or not a credit card is truly the right fit for your wallet.
Let’s explore the different types of credit cards, when opening one makes sense, and the potential pitfalls of adding this piece of plastic to your wallet.
Types of Credit Cards
On the surface, every credit card might seem like the same thing. However, that’s not the case. Different types of credit cards serve different needs. In general, credit cards fall into two categories. Here’s a closer look at the basic types of credit cards.
Secured Credit Cards
A secured credit card requires an upfront cash deposit to finalize your account setup. The cash deposit serves as collateral for your line of credit. With that, the credit card issuer has the option to seize this collateral if you don’t repay your credit card balance.
The required deposit amount ranges from hundreds to thousands of dollars. A wide range of secured credit cards makes it possible to find an option that suits your budget.
As a borrower, the need for a security deposit might be inconvenient. But the deposit eliminates some risk for the lender. With that, lenders tend to be more willing to issue a secured credit card to someone with bad credit or no credit.
Unsecured Credit Cards
An unsecured credit card doesn’t require a deposit to open. If you are approved for an unsecured credit card, you’ll get access to a credit limit set by the credit card issuer. You can spend up to this limit without making a deposit.
The lack of a deposit requirement is a benefit for borrowers. But this adds more risk for the credit card issuer. With that, credit card issuers are more likely to only provide an unsecured credit card to someone with at least fair credit. Many top-tier credit cards are only accessible to borrowers who have good or excellent credit.
When Does a Secured Credit Card Make Sense?
A secured credit card isn’t the right option for every situation. But in some cases, a secured credit card is a perfect choice. Here’s when a secured credit card might make the most sense for you.
If you want to build credit for the first time or rebuild your credit, a secured credit card is a useful tool. Since you are putting down a deposit, the credit card issuer faces less risk of losing money. After all, they can seize your collateral if you cannot keep up with the payments. This lower level of risk means you are more likely to get approved for a secured credit card, even if you have bad credit.
Once you have a secured credit card in hand, using it responsibly can help you build your credit. The key is to make on-time payments consistently. Your payment history accounts for 35% of your FICO score. If you have a history of on-time payments, that leads to a higher credit score. If you don’t have a payment history or consistently make late payments, that will have a negative impact on your credit score.
As you use your secured credit card, you have an opportunity to build a record of on-time payments. Of course, you will hurt your credit score if you don’t keep up with your payments.
Lower Spending Limits
Typically, the credit limit of your secured credit card is tied to your deposit. At first, many secured credit card issuers will limit your line of credit to the amount of your deposit. For example, if you make an upfront deposit of $100, then your credit limit will likely be $100.
The lower spending limits mean you won’t have too much of an opportunity to overspend. If you are worried about the temptation to spend more than you should, the low limit of a secured credit card might help keep your spending in check.
As you build your payment history, the lender might reevaluate your credit limit. You can also request credit limit increases yourself. Over time, you might see your credit limit rise. But the initially low spending limit can act as training wheels while you get comfortable spending with a credit card.
When Does an Unsecured Credit Card Make Sense?
When you think about credit cards, you might initially consider the unsecured option. Unsecured credit cards are a popular option for convenient spending. But unsecured credit cards aren’t the right choice for everyone. Here’s when an unsecured credit card might fit your wallet.
Higher Spending Limits
Since an unsecured credit card isn’t tied to a cash deposit, it’s often possible to unlock a higher spending limit. After all, you won’t need to come up with the funds for a deposit. If you have a good credit score, you might be surprised at the size of your offered credit limit. Of course, if you only have fair credit, you can expect to find relatively low credit limits.
A higher spending limit is convenient because it allows you to use your credit card for big purchases. For example, you could use your credit card to cover a major home appliance. A lower spending limit might force you to use your debit card or cash for large purchases. But that might not be a problem with the right spending limit.
Reliable Spending Patterns
Before opening an unsecured credit card, it’s helpful to have your spending patterns under control. A reliable pattern includes a responsible handling of your spending habits. Not sure if your spending patterns are reliable? Take a look at your transactions. If your spending remains relatively constant over time, you might not have a tendency to overspend. But if you find yourself succumbing to impulse purchases on a regular basis, your spending patterns might not be too reliable.
In general, you don’t want to open an unsecured credit card unless you are confident in your spending behavior. If you think there is a danger of spending more than you should, then avoid opening a credit card. But if you rarely go over budget, then an unsecured credit card might be a good fit.
Ability to Stretch Your Budget With Rewards
Many unsecured credit cards offer reward opportunities. That’s especially true for credit cards available to borrowers with excellent credit. If you qualify for a rewards credit card, you can use the rewards to stretch your spending power a little bit farther.
Most reward credit cards are unsecured credit cards. As a borrower, you can often choose to apply for a travel rewards credit card or a cashback credit card. If you enjoy traveling, racking up reward points on a travel card might give you the ability to splurge on your next trip. If you want the option to spend your rewards on something other than travel, a cashback rewards credit card will help you stretch your dollars further.
Pitfalls of Unsecured Credit Cards
As with all financial tools, there are some disadvantages to using unsecured credit cards. Here’s a look at the major downsides of unsecured credit cards.
Easy to Overspend
The biggest flaw of unsecured credit cards is that you have an opportunity to spend more than you can afford to pay off in a month. When you have a higher credit limit, you can choose to swipe your card for purchases of all shapes and sizes. While that power might feel exhilarating at first, you might quickly find yourself with a credit card bill that you cannot afford.
If you are concerned about overspending, it’s probably a good idea to avoid opening a credit card. But if you are comfortable spending within your means, then opening a credit card shouldn’t lead to any long-term financial damage.
Variable Interest Rates
Most credit cards come with variable interest rates, which means that the interest rates can change over time. If market rates rise, then the interest rate tied to your credit card balance may also rise.
If you carry a balance, high interest rates can make your credit card debt soar. Not only are credit card interest rates variable, but credit card companies are notorious for attaching high rates in the first place. For example, the Federal Reserve reported that the average interest rate on credit card accounts that assessed interest was 20.40% in the fourth quarter of 2022. That’s significantly higher than the average interest rate on a personal loan, which was 11.21%.
If you end up carrying a balance on your card, it can be difficult to dig your way out of this debt.
When to Avoid a Credit Card
A credit card isn’t the right addition to everyone’s wallet. Here’s when to avoid a credit card:
No Emergency Fund
If you don’t have an emergency fund, opening a credit card could be a recipe for disaster. Unfortunately, life often throws curveballs. Without an emergency fund, it’s easy to lean on your credit card to get through tough times.
But if you lean on your credit card too much, you might quickly grow a credit card balance that’s challenging to pay off. If possible, build some level of emergency savings before opening a credit card. Experts recommend building an emergency fund to cover three to six months’ worth of expenses. However, saving any amount will help you avoid sliding into credit card debt.
Emotional spending involves spending money based on a particular experience. For example, you might tend to go on a retail therapy expedition after a bad day at work. Or you might feel pressure to overspend when hanging out with your family.
If you are prone to emotional spending habits, opening a credit card could be a dangerous move. With a high enough credit limit, a retail therapy trip could quickly turn into a long-term debt problem.
Before opening a credit card, do your best to build healthy coping mechanisms. Once your emotional spending tendencies are under control, a credit card might be a better fit.
Frequently Asked Questions
Still have questions about opening a credit card? We have answers.
Is There Any Downside to Opening a Credit Card?
Yes, there are downsides involved when you open a credit card. Depending on your situation, you might spend more than you should on your credit card and get into credit card debt. High interest rates and keeping up with monthly payments could make a credit card a bad choice for your situation.
Of course, there are also advantages to opening a credit card. A few include the opportunity to build a history of on-time payments, potential rewards, and a convenient method of payment.
Should I Get a Credit Card at 18?
You have an opportunity to start building credit by opening a credit card at 18. However, it’s not always the right move. If you aren’t confident in your ability to make on-time payments in full each month, consider waiting to open your first credit card.
If you know that you can keep up with the payments and avoid overspending, then opening a credit card at 18 can help you start building credit. Like most things, building good credit takes time. The earlier you can get started with responsible credit habits, the better off your credit score will be.
If you can’t get a credit card on your own at 18, or don’t feel comfortable opening one yet, consider asking your parents or another trusted individual to add you as a credit card authorized user on one of their credit cards in good standing. This can help you build credit so that you can eventually get your own credit card.
The Bottom Line
A credit card can help you build credit while providing a convenient spending method. But in some situations, opening a credit card can do more harm than good. If you want to open a credit card, take an honest look at your financial situation.
Hopefully, you can easily determine if you can manage a credit card responsibly. If you aren’t sure that you can keep your spending under control, opening a credit card may not be the right choice for you.