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When you've had credit problems, it can be difficult to get approved for most standard credit cards. Because it's nearly impossible to go cash-only today, some card issuers provide a couple good alternatives: secured credit cards and prepaid cards. Both can be used to make secure and convenient payments, but each has its own advantages and drawbacks.
To decide whether a secured card or prepaid card is best for you, you need to determine how you'll be using the card and what your goals are. A secured card can be a great tool for improving your credit, while using a prepaid card won't affect your credit in any way.
With both secured and prepaid cards, you have to deposit a certain amount of money with the issuer before you can use them to make payments. And you can use both to make payments, much like regular credit card, whether at brick-and-mortar institutions or online. But the similarities basically end there. Here's what you need to know.
What Is a Secured Credit Card?
A secured credit card is backed with a refundable security deposit. The biggest advantage of a secured credit card is that card issuers report your payment activity to the three credit bureaus (Experian, TransUnion and Equifax). If you make your payments on time and keep your credit utilization ratio (the portion of available credit you're using) low, you'll build your credit history and likely improve your credit scores.
Some secured cards also offer users benefits that are available on regular credit cards, such as price protection, rental car insurance and extended warranty coverage. You'll also usually get the same legal protections in case of fraud, such as zero liability on unauthorized charges.
Secured cards may charge a variety of fees, such as annual fees, application fees or maintenance fees, and they often charge higher interest than other types of credit cards. Make sure you understand and compare terms when you're looking for a secured card, and commit to paying off your balance every month to avoid costly interest charges.
How Does a Secured Credit Card Work?
You must apply for a secured credit card just like you would any other credit card. Because secured cards are backed by a security deposit, credit issuers are more likely to approve users with a poor credit history than they are with regular unsecured cards.
Once approved, you submit a refundable security deposit, which typically serves as your credit limit. So if you deposit $500, that's the amount of credit you are extended for the card. You then use your card for purchases just as you would any other credit card.
As with any other credit card, you receive monthly statements and need to make monthly payments. If you don't pay off your balance in full every month, then you will incur interest charges. And if you don't make your payment on time, you'll incur late fees. If you ever default on your payments, your issuer will use the security deposit, and you will forfeit that deposit.
When you can qualify for a standard unsecured card, you can pay off your remaining secured card balance, close your account and receive a refund of your security deposit. Some card issuers will automatically move you to an unsecured card once you've used your card responsibly for a certain amount of time.
Secured Card Options
Capital One® Secured Mastercard®
This secured card has no annual fee and requires as little as a $49 refundable security deposit to receive a $200 line of credit. Capital One may also consider you for a higher credit limit in as little as six months. There's no annual fee for this card and no foreign transaction fees either.
Discover it® Secured
The secured card version of the Discover it® card requires a refundable security deposit of at least $200 after being approved before an account can be opened, and the amount of your deposit becomes your credit line. This card offers you 2% cash back at gas stations and restaurants on up to $1,000 in combined purchases every quarter, and unlimited 1% cash back on all other purchases. Even better: Discover will match all the cash back you've earned in your first year. You also get an automatic review of your account starting when it's 8 months old to see if your account can be transitioned to a standard unsecured card. There's no annual fee for this card.
What Is a Prepaid Card?
A prepaid card is a type of debit card that's not attached to a bank account. Like a secured card, it also requires you to make a deposit before you can use it. However, you don't need to apply for a prepaid card the same way you do a secured credit card: There's no credit check, so you don't have to worry that you will be turned down.
The prepaid card acts more like a debit card, and the amount of money you load onto it is how much you can spend. When you pay for something with a prepaid card, the amount is deducted from your card balance. Once you've used up the amount of your deposit, you need to load more funds onto the card before you can use it again.
You won't incur late fees on a prepaid card because you don't ever have to make monthly payments. But you also won't build up a credit history using a prepaid card, because your usage isn't reported to the credit bureaus.
Prepaid cards don't assess annual fees or finance charges, but there are other fees you need to be aware of. When using a prepaid card, you may be charged a small fee every time you make a purchase. Other cards may assess users an activation fee or a monthly maintenance fee. You may even be charged a fee to simply load more money onto the card. Each prepaid card is different, however. Some don't assess usage fees at all, so it's important to understand the terms before signing up for one.
Can You Build Credit With a Prepaid Card?
No, you cannot build credit with a prepaid card. Since prepaid cards only allow you to spend money that you've already deposited into an account, they are not considered a loan. And because prepaid card users aren't borrowing any money, their balances and payments aren't reported to credit bureaus. That means that prepaid accounts won't appear on your credit report or have any effect on your credit scores.
Secured Card vs. Prepaid Card: Which Is Best for You?
If your goal is to build a credit history, a secured card is the clear choice here. If you make your payments on time and carry little, if any, debt, then you'll add positive information to your credit history and likely improve your credit scores.
But if you simply want an alternate method of payment, a prepaid card may be a good option. With a prepaid card, there will be no security deposit, and you'll immediately have access to all the funds you place into your account. Also, you can never go into debt or incur interest charges with a prepaid card.
A prepaid card can also be a good way to budget: The amount you load onto a prepaid card can be designated for a certain time period, like a week or a month, and once you've spent it, you are forced to stick to your budgeted limit. Some parents might choose a prepaid card for their children if they want to offer them a set allowance.
Prepaid cards and secured credit cards look a lot alike, and can both be used to make purchases, but that's where the similarities end. By understanding the strengths and weaknesses of these two methods of payment, you can choose the right one for your needs.