4 Disadvantages of a Secured Credit Card

A secured credit card uses an asset as collateral to extend financing. There are a number of different assets a bank or credit card company will accept, which include: homes, cars, businesses, stocks and even savings accounts. Secured financing is typically cheaper than unsecured financing because it is less risky for the lender. The reduced risk means you will get lower interest rates, and you will usually see better terms on the credit line. However, securing a card against an asset also has disadvantages. 

Risk of Asset

Whenever you secure a credit line against an asset, the biggest risk is always that you may lose that asset, in the case of default. For example, if you get financing against your car, the lender can seize your car if you fail to meet the terms of your loan.

The seizure typically occurs without any notice. Lenders often collect at your office, or school, in order to prevent you from fleeing with the asset. You can protect yourself against this situation by saving wisely and having an emergency fund. While you may think there is no chance you will default, losing a job or having a medical emergency can be unpredictable and cause loan default.

Subjective Limits

Your lender will give you credit card limits based on their valuation of your asset. Your limits are subjective to how the lender evaluates your asset. The lender will typically extend only a portion of the total value in financing.  For example, a lender may give you 75% of the total amount of funds you have in your savings account on your credit card. If you default, though, they will seize your whole account. In the end, you are always risking more than the lender in order to secure financing.

Negligible Affect on Credit

When you use an asset to secure a loan, your credit report will reflect the status of the debt. An unsecured loan will appear as an increase to your general financial strength. A secured loan will show the exchange of the asset, and the asset will effectively be removed from your total assets on your balance sheet. This is particularly important for a business that keeps more exact asset records for investors or board members.  

Further, when you make monthly payments on a secured loan, you will not see as much of a boost in your credit score. Getting an unsecured loan is harder to do, and paying off an unsecured loan will boost your credit more than paying off a secured loan. 

Adjustable Rates

Most credit cards have adjustable rates. These rates fluctuate with your personal credit score and with the national prime interest rate. Your financing may cost more one month than it does the next month if rates adjust. Today, it is illegal for interest rates to change on existing debt, without proper notice. This means the purchases you made last month will be assessed at last month's interest rate. However, the cost of financing in the future is still unpredictable. Protect against this by writing rate terms into the contract that prevent the rates from adjusting too high.

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