Should You Use Your Home or Car as Collateral for a Credit Card?
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Secured credit cards are a credit-building solution for people with bad or limited credit. Approval for a secured credit card is largely based on one’s ability to put up the cash deposit, usually $200-$300, which becomes the card’s credit limit.
But a deposit requirement can present financial hardship. Cardholders get the full deposit back when they close the account or upgrade to another card from the same issuer, but not everyone can afford to tie up cash indefinitely.
Some financial technology companies are offering solutions for limited liquidity: asset-secured cards. Credit limits on these cards are backed by collateral like fine jewelry, a car or home equity. As such, credit lines on asset-secured cards can be higher, and interest rates may be lower, compared with a traditional secured card.
As asset-secured cards have solved one problem, they’ve created a few more. Some of these cards require cardholders to send away their collateral items or car title. A bigger credit line means more spending power but could also lead to bigger debt. Plus, defaulting on these cards could result in the loss of something essential to one’s livelihood.
Brian Riley, director of credit advisory services and co-head of payments at Javelin Strategy & Research asks, “Do you really want to put everything at risk in a credit card?”
For the right person, the benefits of asset-secured cards could outweigh the risks. But they’re not for everyone. “These products aren’t necessarily bad, but enter into them with eyes wide open,” Riley says.
Lower interest rates
Credit card interest rates have risen as the Federal Reserve has hiked the federal funds rate to fight inflation. As of August 2023, the average interest rate on interest-accruing cards was 22.77%. This financial environment gives some asset-secured cards instant appeal.
“The advantage of these products is the lower interest rate,” says Jessica Duncan, assistant vice president of research and insights at Competiscan, a market research company. “If they’re putting a balance on the card, it’s revolving at 8% rather than 26%.” For example, the card from fintech Aven that’s backed by home equity has interest rates as low as 7.99%.
If you’re carrying a credit card balance from month to month, a single-digit interest rate can make debt payoff more manageable. But if you pay your bill in full each month, the card's annual percentage rate doesn't matter since you'll never be charged interest.
Higher credit limit or higher credit score?
With asset-secured credit cards, the collateral item’s value determines the credit limit. For people who own something valuable but don’t have a high credit score, these cards could unlock credit lines typically reserved for those with good to excellent credit. James Savoldelli, founder and CEO of Pesto, the fintech behind the card secured by items like jewelry, says that cardholders have put up collateral worth $20,000.
For some, a big credit line is a lifeline that covers expenses when cash runs dry. But for others, it can be a debt trap. Traditional secured cards mitigate the risk of overspending by imposing credit limits, often at a few thousand dollars. That’s by design: Cards secured by small cash deposits aren’t financing tools; they’re meant to help people build credit through responsible use.
That goal seems secondary when it comes to some asset-secured cards. Pesto says it wants to give you fast access to credit; Yendo, the company behind the card secured by a vehicle, says it’s helping “people [who] need extra money to make ends meet.”
Plus, a bigger credit line won’t, on its own, lift one’s credit score. Accounts that have revolving balances and near-maxed out credit lines can drag scores down. Since some of these asset-secured cards report to at least one of the three major credit bureaus, that type of credit activity will be captured on a credit report.
Any credit card can help consumers improve their credit, but it may be harder to do with an asset-secured card.
Collateral loss
Credit card defaults are serious matters that can result in damaged credit, among other consequences, but defaulting on an asset-secured card may have worse outcomes.
Depending on the collateral backing the card, cardholders could lose their car or home due to default. Jordan Miller, CEO and co-founder of Yendo, and Savoldelli both say that their companies want to help cardholders avoid default and have procedures in place to assist those in danger of doing so. Still, defaults are bound to happen. “[The economy] is so volatile now,” Riley says. “If unemployment goes to 10%, it’ll affect a lot of people’s ability to repay.”
Asset-secured cards are a better gateway to credit and low interest rates than options from a pawnshop or car title loan, which also require collateral. It’s also true that unequal access to credit is a problem in the U.S. Whether the answer to that problem is asset-secured cards is for consumers to decide.
“You have to question the why, you have to question the alternatives. There are plenty of alternatives that would forestall you from putting your house or Rolex up as collateral,” Riley says.
This article was written by NerdWallet and was originally published by The Associated Press.
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