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While prepaid cards are convenient and often safer alternatives to carrying cash, they won't help you build your credit scores.
What Is a Prepaid Credit Card?
A prepaid credit card is essentially a substitute for cash. These cards may look exactly like a credit card or debit card, and function similarly to a debit card. Like a debit card, a prepaid credit card requires that you have money in the account before you can make a purchase. You can load money onto your card through direct deposit from your bank account or with cash.
When you use a debit card, money is withdrawn from your checking account. With prepaid cards, you can only spend as much money as you've added to your card. As you use your prepaid credit card, the amount of your purchases is deducted from the balance. Once you've used your entire balance, you must reload more money onto the prepaid credit card before you can use it again.
While you don't pay interest on prepaid cards as you do with credit cards, you may incur fees. The fees for prepaid cards vary depending on the card and can include monthly use fees, transaction fees and cash reloading fees. By comparison shopping and reading the disclosures for the prepaid cards, you can keep the fees to a minimum.
Does Using a Prepaid Card Affect Your Credit?
With a prepaid card, you aren't borrowing any money. Prepaid credit cards don't have a credit line attached to them, and they aren't reported to the credit reporting agencies, so they won't help improve your credit scores. Although prepaid cards and traditional credit cards often look the same and are used the same way when making purchases, prepaid cards can't help you establish your credit history.
If you are trying to build credit, consider opening a traditional credit card account, technically referred to as a revolving account because you can carry a balance, or revolve, from month to month. Revolving credit card accounts are great indicators of whether or not you are a good credit risk because they allow you to make choices about how much to charge and how much to repay each month.
When Is a Prepaid Card a Good Option?
Prepaid cards can be useful if you are looking for an alternative to paying cash but are unable to qualify for a credit card. Although prepaid cards won't help your credit scores, you can still benefit from the convenience and structure of using a card to make purchases. Prepaid cards also offer fraud protection if your card is lost or stolen, so it can be a safer option to carrying cash, especially when traveling.
Because you can only spend what you've loaded onto your prepaid card, this eliminates the possibility of charging more than you can afford and incurring any high interest fees. These types of cards also offer the convenience of reloading funds online, over the phone or at any ATM.
Prepaid Card Alternatives to Help You Build Credit
If qualifying for a traditional credit card account isn't possible, there are other options, such as asking a friend or family member to add you to one of their accounts as an authorized user or getting a secured card.
When someone adds you as an authorized user to their credit card, they may or may not give you permission to make purchases on their credit card account, but they are responsible for all payments. If the credit card company reports its authorized user accounts to the credit bureaus, the account will appear on your credit report and can be factored into your credit scores. As a result, being an authorized user on an account with a positive payment history can help you establish credit and improve your credit scores.
Another alternative to prepaid cards are secured cards. With most secured cards, you deposit funds into a savings account and receive a credit card with a limit that is typically the same amount you deposited. Because secured cards use the amount you deposit to "secure" the amount you charge on the card, they are easier to qualify for. You still pay a monthly bill, and if you pay late, your credit scores will take a hit.
When applying for a secured card, check with the credit card issuer to ensure they report their secured account information to the credit reporting agencies. As long as the account is reported and used responsibly, it can help you rebuild or establish your credit history.
You may also be able to improve your credit history by having your positive utility and telecom payments added to your credit report. Experian Boost™† enables you to add your cell phone, gas, electricity and even cable television payments to your Experian credit file, possibly resulting in an instant credit score increase.
The Bottom Line
Prepaid cards are easy to obtain and offer the convenience of making purchases without carrying cash. They also offer some of the benefits of a traditional credit card, such as fraud protection. However, they don't have credit lines and won't help credit scores. Learn more about establishing credit and improving your credit scores to see what other options can help you as you work to boost your credit.