What is a Closed-Loop Credit Card?

Everyone has a favorite store (I know I do) — the one I would choose over all the other competitors no matter where I was in the world. Maybe it’s the shop’s nifty layout that keeps me coming for more. Or maybe it’s because it’s conveniently located near my home for quick drop-ins. 

While the in-store vibes can make a shopping experience stand out, we can all agree that saving money is a strong reason for choosing one store over another. Getting a store-branded credit card with an already great store can make the shopping experience that much better.   

Also known as store-branded cards, a closed-loop card is a credit card you can only use to make purchases at a specific retailer or a group of affiliated retailers. These types of cards can make an excellent addition to your wallet because they can maximize your shopping experience with exclusive rewards and benefits — if you are loyal to a specific retailer. 

I’ve researched the basics of closed-loop credit cards, how they differ from open-loop cards, and their benefits and drawbacks so you don’t have to. 

Many stores, including Macy’s and Target, offer closed-loop credit cards. By doing so, they can encourage you to return and shop at their store more often. Here are some basics about closed-loop credit cards so you can better understand what you’re signing up for.

Typical Usage Restrictions

Closed-loop credit cards have the word “closed” in their name for a reason. In this case, closed means that you can only use the credit card at the issuing retailer.

Although you can’t make purchases at other stores, some store-branded cards allow you to buy with their card at affiliated stores. For example, Gap cardholders can also use their cards at Athleta, Old Navy, and Banana Republic, which are Gap affiliate brands. 

Issuing Entities

Closed-loop credit cards aren’t limited to retailers. A variety of merchants offer branded credit cards, including gas station chains (ExxonMobil) and coffee shops (Starbucks). 

Most merchants create partnerships with financial institutions to issue their credit cards. For example, Best Buy partners with Citibank to issue its store cards, including its My Best Buy Credit Card. Costco is another store that partners with Citibank to issue its credit cards.

Retailers often offer their store cards with loyalty programs and/or store benefits. Using a store card in conjunction with a loyalty program can maximize your earnings to the next level. 

Let’s use Target — one of my favorite stores — as an example. You can sign up for the Target Circle Rewards Program to enjoy daily deals, discounts, and partner perks. However, you can save even more with its Target Circle Credit Card, which offers a 5% discount off purchases and free shipping on most items at Target.com. 

Combining a store-branded credit card with a loyalty program can provide a wealth of benefits and take your savings to the next level. 

There are several store-branded credit cards with favorable terms. Hearing the introductory discount could motivate anyone to sign up for a store card. But beware — some cards can be credit traps with high interest rates and fees. 

Credit Limits

Let’s start with credit limits. Closed-loop credit cards often have lower credit limits than open-loop cards. Most store cards have a maximum limit below $3,000. 

Credit limits also vary by retailer. That’s because merchant policies determine the limit you receive. Your creditworthiness or credit history can also play a role in how much credit you receive. 

For example, you might sign up for a card and have no prior credit history. You will most likely be rewarded a lower limit than a person with an excellent credit rating. 

Of course, a card with a $3,000 limit would be much more enticing. But having a credit card with a lower limit can also teach you to build good financial habits as you build your credit history. It can help you establish conscious spending and better payment habits for the future. 

Interest Rates and Fees

Closed-loop cards have various terms and fees. It all depends on the issuing bank’s policies. Interest rates are one area where you’ll see the most variation. 

Store credit cards tend to have higher interest rates than other general-purpose cards. According to Bankrate, the average store card charges a 28.93% APR, while general-purpose cards have an average APR of 21.19%.  

High interest rates can be a problem if you keep a balance on your card. The best way to enjoy the benefits of your store card is to keep a low balance and pay it off in full every billing cycle.

You may also face other fees, including annual fees, late payment fees, and other charges while using your card. Although most retail cards I researched have zero annual fees, consumers still have to pay late fees as they do with general-purpose cards. 

You may be tempted to jump at the first sight of a deal. And I can’t blame you — retailers know how to sell a promotion. But in the case of store cards, fine print is your friend. Reading it may extend the application process, but it can help you avoid a disastrous credit situation.  

Impact on Credit Scores

Store credit cards can actually serve as a great launching pad for boosting your credit score. Your odds of getting approved for a store credit card may be higher. So whether you have a fair credit score or no history at all, you can apply. 

Closed-loop cards can easily bolster your credit. With regular use and timely payments, you can build your credit score up using a store-branded credit card.  

There are pitfalls to watch for as well. Closed-loop credit cards can cause a lot of damage if you’re not careful with your credit usage and payment schedule. And a lot of that has to do with its limited usage and how it can impact your credit utilization ratio.

A lower credit limit can be a blessing and a curse. It can motivate you to stay on budget and not overspend at your favorite shops. However, extremely low credit limits can cause you to teeter on the edge of maxing out your available credit (even with low balances!), causing your score to drop due to credit utilization issues. 

The credit utilization ratio is the percentage of your outstanding balance compared to your card’s total limit. It is recommended, according to popular credit scoring models, to keep your credit utilization at 30% or below. 

To maintain a solid credit history, you can implement automatic payments and try to keep your credit balance low until you get approved for more credit. 

Closed-loop cards are all about incentivizing customers for their loyalty. It’s simple: you spend more, you get more rewards and discounts. Signing up for the exclusive closed-loop club can be enticing, but open-loop credit cards can also be a great tool for your wallet. 

Acceptance and Flexibility

Closed-loop and open-loop credit cards have several differences, but with their own advantages. One of the main reasons you may choose one over the other is their flexibility. Here are some of the differences. 

Closed loop: If you’re not in the loop, you’re not in the loop. This saying definitely applies to closed-loop cards. Acceptance is two-sided for closed-loop cards, and it’s limited. The first caveat is that you can only apply for a closed-loop credit card with a specific retailer, and that may entail signing up for their loyalty program. 

Closed-loop credit cards are exclusive items. So not only do you have to apply with a specific retailer, but you can only use the card to make purchases with the issuing retailer or within its network of affiliated brands. 

Open loop: Open-loop cards are more inclusive. You can use open-loop credit cards anywhere because their acceptance policies aren’t as limited as closed-loop cards. 

Most merchants offer closed and open versions of their retail cards. If you sign up for an open-loop card, you’ll have the opportunity to make purchases with the card at the issuing merchant’s store and other stores.

A way to identify an open-loop card is by looking for a Visa or Mastercard logo on the card, which means it can be used everywhere Visa or Mastercard is accepted.

Rewards and Incentives

Who doesn’t love rewards? Thankfully, both closed-loop and open-loop credit cards offer rewards and incentives to motivate your card usage. 

Closed loop: Stores with closed-loop cards often provide tailored rewards for specific store purchases. Benefits can vary but usually include discounts, cash back rewards, and free shipping. These benefits are used to incentivize customers to regularly shop with its issuing retailer.

As it happens, closed-loop cards are usually linked to brand loyalty programs. Some stores require you to be a member to apply for their cards, and those memberships often carry great benefits. So that means you will get to explore and leverage even more perks in addition to your credit card rewards. 

Open loop: Open-loop cards allow you to make purchases anywhere. You may also receive rewards across more categories. 

Open-loop credit cards often have general rewards programs that allow you to earn points everywhere you shop and get additional points while shopping with the issuing merchant. 

The Application Process

The application process is typically the same for both types of cards. They require the same types of information, but the credit qualifications differ.

Closed loop: When applying for a closed-loop credit card, your credit history still plays a role, as with other credit cards. But closed-loop credits are often easier to qualify for, with more lenient credit requirements.

Issuers follow an in-depth approval process no matter the type of card, typically based on algorithmic underwriting. They will carefully analyze your credit history and creditworthiness before approving you for either type of credit card.

Open loop: Most open-loop retail cards have stricter credit requirements and are generally targeted to applicants with good or excellent credit.

The bottom line is that retailers generally offer both closed-loop and open-loop cards, but your credit history will determine which type you qualify for. But the process of applying is the same for both.

Closed-loop credit cards can make great starter cards for people with a limited credit history,  but they also have a few drawbacks to consider. Understanding the benefits and drawbacks can help you decide whether to apply for a store credit card.

Benefits

Closed-loop cards may offer an easier approval process. If you do have a lower credit score, these cards can help you build your credit.

But timely payments and regular use are still crucial contributors to positive credit reporting. Make sure you maintain good financial habits while using your store credit cards. 

Closed-loop cards also typically have lower credit limits than traditional credit cards. Although this may seem like a negative, it can actually help first-time cardholders and others learn to responsibly manage credit. 

Lower credit limits help prevent excessive debt accumulation. This way, you can keep a low credit balance that you can pay off more easily. 

Another benefit of closed-loop cards is the rewards program. Often, in exchange for signing up for a card, stores can offer you an introductory promotion. For example, you could receive a 20% discount on your initial purchase with the card.  

The rewards often don’t stop there. Merchants tend to hand out exclusive discounts, promotions, and complementary loyalty programs with their credit cards. As long as you meet the reward policy’s requirements, you will get benefits as you use your issuer’s credit card.

Drawbacks

The biggest drawback of closed-loop cards is the restriction to the issuing retailer or group of merchants. This factor can significantly limit your purchasing options. 

Although you can shop with your retailer or within its affiliated brand network, you can’t use a store-branded card for anything else. So it won’t be suitable for emergency situations or earning points across broader categories. 

Limited acceptance may mean limited opportunity to earn rewards, but if you regularly shop at your issuing store, a closed-loop card can be worth it. 

Another aspect to watch out for is high interest rates. Most retail cards have higher APRs than traditional credit cards not affiliated with a retailer. So paying off your full balance month to month is crucial to dodging the woes of accrued interest. 

Some stores could offer a 0% financing promotion. But like all promotions, your 0% financing will end. And this is where deferred interest comes in. 

Once the promotion ends, you will have to pay retroactive interest on the entire purchase if you still have a balance. I’ll give you an example. If you buy a $500 laptop and have $50 left on your balance at the end of the financing promotion, you may have to pay interest for the total cost of the laptop. Not fun, right?

I recommend reading the terms and conditions of your issuing merchant’s credit card before making any decisions. This can inform you about the policies they use and help you determine whether the card will be a good fit.

Closed-loop credit cards can be a great savings tool in today’s economy. And store-branded credit cards may offer you exclusive discounts at your favorite stores so you can maximize your savings and rewards. 

Thinking of my favorite stores, I can see why closed-loop credit cards can be enticing. However, you should understand the limitations of your closed-loop credit card before applying. Lower credit limits and higher APRs can negatively impact your finances and leave you without as much purchasing flexibility. 

But benefits can often outweigh the negatives. In this case, store-branded credit cards have many benefits. So whatever you decide, you’ll be in for some happy shopping.