Are you pondering over why secured credit cards are labeled as less risky for lenders? Well, you've landed on the right page to get your answer! In this article, we'll dive deep into understanding secured credit cards and why financial institutions perceive them as a safer bet. Let's take a journey together and unlock some valuable financial wisdom along the way!
Why Are Secured Credit Cards Less Risky For Lenders Table of Contents
What Are Secured Credit Cards?
To fully appreciate the factors that make secured credit cards less risky for lenders, first, let's grasp what they truly are. A secured credit card is a type of credit card that requires a security deposit, which serves as collateral for the credit limit provided. The deposit acts as a safety net, ensuring the cardholder will pay off their debt. Secured cards are typically used by people with no credit history or low credit scores to build or improve their credit profile.
How Do Secured Credit Cards Work?
- Apply for a secured credit card from a financial institution
- Provide a security deposit – usually equal to your desired credit limit
- Use the card just like a regular credit card – make purchases and pay off the balance monthly
- On-time payments help build/improve your credit score
- Eventually, you can potentially upgrade to an unsecured credit card
Why Secured Credit Cards Are Less Risky for Lenders
Now that we know what secured credit cards are and how they work, let's delve into the factors that contribute to their reduced risk factor for lenders.
1. Collateral Reduces Risk of Default
The primary reason secured credit cards pose less risk to lenders is the security deposit acting as collateral. Should a cardholder fail to make their monthly payments, the financial institution can use this deposit to recover the owed amount. This significantly reduces the risk of default, providing reassurance to the lender that they will not lose out on their investment.
2. Lower Credit Limits in Comparison to Unsecured Cards
Secured credit cards usually have lower credit limits than unsecured cards, with many lenders offering limits equal to the security deposit. This reduced borrowing capacity further minimizes the potential loss for lenders in instances of default.
3. Attracts More Responsible Borrowers
Individuals who opt for secured credit cards are usually more conscious of managing their credit profiles, as they want to build or repair their credit scores. This willingness to be responsible borrowers and the earnest effort they put into improving their financial standing results in reduced risks for lenders.
Why Are Secured Credit Cards Less Risky For Lenders Example:
Suppose Jane has a poor credit score due to past financial mistakes. To improve her credit and regain her financial footing, she applies for a secured credit card from a reputable lender. She provides a $500 security deposit, which determines her credit limit.
Over the next several months, Jane uses her secured credit card responsibly, making all payments on time and never exceeding her credit limit. As a result, her credit score improves, and she begins to receive offers for unsecured credit card products.
The lender has faced minimal risk throughout the process, thanks to Jane's security deposit and her determination to be a responsible borrower. This example showcases the reduced risk that secured credit cards pose for lenders.
Now you have a comprehensive understanding of why secured credit cards are less risky for lenders! Armed with this knowledge, you can make better financial decisions and choose the right credit products to suit your needs.
But the learning doesn't stop here! Flik Eco has a plethora of personal finance tips and resources for millennials just like you. So why not share this article with your friends and explore other guides on Flik Eco to keep building your financial knowledge? Together, let's make sure we're staying ahead of the financial curve!