Credit Card Basics

Prepaid Card Basics

Over the last few years, there has been explosive growth in the use of prepaid debit cards. In fact, use of these cards rose by 50% between 2012 and 2014 alone, according to a Pew survey. In 2015, a 2016 Federal Reserve study showed that in 2015, growth dropped slightly, but it is still clear that what began as a convenient payment method for those without access to banking services has now become a popular alternative to traditional bank accounts, especially among the Millennial generation.

Prepaid Card Basics

  • Prepaid cards are a great option for those who shy away from banks
  • You can make purchases from merchants that accept payments from your prepaid card's network
  • Prepaid cards require you to deposit funds before using the card
  • Prepaid cards generally cost more in fees
  • These cards do not help you build credit because accounts are not reported to the credit reporting agencies

What Are Prepaid Cards?

When you hold one in your hand, a prepaid card looks a lot like a credit card or a debit card issued by a bank, but the similarities end there. As its name suggests, a prepaid card must be loaded with funds before you can make a purchase.

Prepaid cards are sold at many retailers including supermarkets, gas stations, office supply stores, and drug stores. You can also order some prepaid cards online. When you purchase a prepaid card from a retailer, you can specify the amount of money that you want loaded on the card, often with a limit of $500. Most of the time, you will have to purchase a prepaid card with cash or a debit card, not a credit card.

Some prepaid cards are not reloadable. These non-reloadable cards are usually called gift cards, and they considered disposable after their value is used up. On the other hand, reloadable prepaid cards can be replenished with funds over and over again. There are many ways to add new funds to a reloadable prepaid card. For example, there are thousands of retailers that offer customers the ability to reload popular prepaid cards with cash, or sometimes with a debit card. You can also reload a prepaid card with direct deposit from your employer, or even from a federal tax refund. Prepaid cards often allow you to transfer funds directly from your checking or savings accounts. Finally, some prepaid cards can be reloaded with a check.

Using a Prepaid Card

As part of a payment network such as Visa, MasterCard or American Express, a prepaid card can be used to make purchases from any merchant that accepts any form of payment in that network. Each time you use a prepaid card, it will authorize a purchase up to the amount of funds remaining on the card, but not more. If you don't have sufficient funds loaded on the card to make a specific purchase, then the transaction will be declined.

Also, there are some types of purchases that work a little differently with a prepaid card. When a merchant is unable to know the total charge at the beginning of a transaction, then there will be a temporary authorization on your prepaid card, also called a hold. For example, when you use a prepaid card to purchase gasoline at the pump, there will initially be a hold on the card for a large amount, often $75, meant to represent the maximum charge you can make. Only after the charge is settled, perhaps after a day or two, will the actual amount be charged to your card and the hold removed. To avoid these holds, you can pay the actual amount to the attendant in the gas station, rather than at the pump. You may have a hold placed on your prepaid card when you use it to rent a car or to pay for a hotel stay. These holds are to be used to pay for any damages.

Many prepaid cards can also be used to withdraw cash from ATMs, however there's usually a fee associated with these transactions in addition to a small fee you'll usually have to pay to the financial institution who manages the ATM. To use your prepaid card at an ATM, you need to create a four-digit personal identification number (PIN). You can also use your PIN to make certain transactions that require a debit card. Finally, some prepaid cards allow you to make online bill payments to any person or business.

How Are Prepaid Cards and Credit Cards Different?

Despite working nearly identically at the store, there are several significant differences between prepaid cards and credit cards. A prepaid card requires you to deposit funds before you can make a purchase, while a credit card represents a loan that you must repay. You must also apply for a credit card and your application can be rejected, while prepaid cards are issued to all applicants once their identity is verified. And because a credit card purchase is considered a loan, your credit card's statement balance and your payment history are reported to the major consumer credit bureaus, while prepaid cards are typically not reported. Therefore, using a credit card, and maintaining a good payment history on your account can help build your credit history and help improve your credit score, while use of a prepaid card will not.

Credit card transactions are also protected by the Fair Credit Billing Act, which includes robust protections against both fraudulent charges, and charges for things that you never received. With a prepaid card, you're still covered against charges that you didn't authorized, but there are fewer protections when you don't receive what you paid for.

Credit cards can also come with many cardholder benefits that you won't receive from a prepaid card. For example, many credit cards include valuable travel insurance and purchase protection benefits, which are never found on prepaid cards. Credit cards can also offer rewards for purchases in the form of points, miles or cash back.

The Differences Between a Prepaid Card and a Debit Card

Prepaid cards have much more in common with debit cards than with credit cards. The main difference is that debit cards use funds from your checking or savings account, while prepaid cards are essentially an account by themselves. Also, debit cards will use the fee structure of your bank account, while prepaid cards will have their own fees, which can be higher.

The Advantages of Prepaid Cards

A prepaid card is a convenient method of payment, and it requires very little time or cost to get one. You don't have to visit a bank or submit an application to get a prepaid card, which is usually available online or at stores all over your community. And unlike a credit card, you don't have to have a credit history to get a prepaid card. Using a prepaid card also guarantees that you will never have to pay interest charges on your purchases. A prepaid card can also be used by minors and young adults, while you need to be 18 years old to open a credit card account in your name.

The Drawbacks of Prepaid Cards

Prepaid cards can have more fees than most credit cards. Most prepaid cards require a monthly maintenance fee, although many will waive that fee for those who use direct deposit or when you add a minimum amount of funds to your card each month. Other common charges can include fees for ATM use, foreign transactions, cash reloads and card replacement. Some cards will even impose fees on each transaction. As mentioned above, prepaid card will not help you build credit since the accounts are not reported to the credit reporting agencies.

How to Choose a Prepaid Card

When shopping for a prepaid card, you will first want to consider how you will use it. For example, if you plan on loading it using direct deposit from your employer, then you don't need to worry about where you can reload it with cash, or how much that will cost. But if you'll be loading your prepaid card with cash, then you'll need to find a card that has a reload network that's convenient to you. You should also consider if you need to use the card for ATM withdrawals or online bill payments.

Next, take close look at all the fees you will be charged, based on how you plan to use your card. Obviously, you will want to pay as few fees as possible, but you should look for easy ways avoid fees. For example, some cards will have a high fee for ATM use, but will waive those fees when used at machines that belong to a certain network. Other prepaid cards will waive monthly fees for those who regularly use direct deposit, or load a certain amount of funds each month.

Finally, you can look for some additional prepaid card features that may be valuable. For instance, some prepaid cards allow you to order additional cards for authorized users, and set limits on their use. This can be a great feature when you need to extend your purchasing power to other family members.

Bottom Line

As prepaid cards become one of the most popular methods of payment, it's even more important to understand how they work, and how they are different from credit and debit cards. By carefully considering their advantages and drawbacks of prepaid cards, and knowing all of their potential fees, you can make the best decision for your needs.