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Prepaid credit cards allow you to pre-load money onto the card and use it during point-of-sale transactions. A prepaid card is kind of like buying yourself a gift card. Prepaid credit cards may have some advantages over regular credit cards. For instance, with the typical credit cards, the risk of falling into debt is always looming. That’s because you can generally spend up to your credit limit, while carrying a rotating monthly balance that quickly racks up interest. Enter prepaid credit cards as an alternative. While these cards have their own drawbacks and benefits to consider, they could fit your financial needs.
Prepaid Credit Cards, DefinedA prepaid credit card, also sometimes known as a prepaid debit card, is a type of card onto which you load a specific amount of money that you can then spend. Some cards allow you to reload money multiple times.Because a prepaid credit card is linked to cash you already have, it’s not a loan or extension of credit. This means you don’t have to worry about credit card interest charges. However, you also don’t get the opportunity to build your credit, which is one of the plus sides of traditional credit cards if they’re used responsibly. Additionally, some prepaid credit cards come with high fees or long waiting periods before you can access the money you load onto the card. As with any financial product, it’s important to make sure you know exactly what you’re signing up for, so you don’t find yourself in a sticky situation after the fact.
How Prepaid Credit Cards WorkThe way prepaid credit cards work is pretty simple: you choose a card with terms you like, load money onto the card (usually via direct deposit, bank transfer, or in cash), and then use the money to make everyday purchases.In the process, you may be responsible for activation fees, monthly fees, ATM fees, inactivity fees and other costs. It may also cost you money to load the card with cash at retail cash registers.
Pros and Cons of Prepaid Credit CardsPrepaid cards do have some drawbacks. Since a regular credit card is basically a kind of flexible, up-front loan, borrower behavior is reported back to the credit bureaus — and your on-time, in-full payments can add up to a better credit score over time. With a prepaid credit card, your credit score won’t get any boost.Prepaid credit cards do also have benefits, though, especially if you’re not sure you’re ready for a real, interest-bearing credit card. For instance, prepaid cards can be an excellent alternative to credit cards for students, who might still be learning about responsible financial habits. They can also be a good option for those who don’t have or don’t qualify for a bank account, since in many ways they pretty much operate like a debit card (though just not connected to a bank account).And, of course, for anyone who struggles with avoiding credit card debt, a prepaid credit card gives you the option of paying in plastic, but with a definitive endpoint and a lack of interest charges. Here are some of the pros and cons of prepaid credit cards at a glance:
|Pros of Prepaid Credit Cards||Cons of Prepaid Credit Cards|
|• No risk of going into debt or accruing interest charges||• No opportunity to improve your credit score with good card behavior|
|• No credit check required to qualify||• Fees may add up|
|• More secure than carrying cash around||• Depending on the type of card and whether you register it, they may not be accepted everywhere|
Different Types of Prepaid Credit CardsWhile there are dozens of different prepaid credit cards on the market, they fall into two major categories — and it’s really important to know the difference.
For most, an open loop prepaid credit card is the better option, though it’s still important to understand that you might run into issues when attempting to make certain transactions with a prepaid card, such as reserving a rental car. Since rental car companies usually put a large hold on your credit card (in case of damage to the vehicle), there’s a chance you may also be required to put down a cash deposit if the amount on your prepaid credit card is less than the damage deposit.It’s also possible that the rental car company — or any other business, for that matter — may categorically refuse to accept prepaid credit cards. Ideally, you don’t want your prepaid card to be your only spending option. Recommended: Guide to Getting a Credit Card for the First Time
- Open loop prepaid credit cards are those that can be used just about anywhere cards are accepted. These cards are branded with the logo of a major card issuer, like Mastercard or Visa.
- Closed loop prepaid credit cards are those designed to be used only at a certain store or family of stores.
Choosing a Prepaid Credit CardAs with any credit card, when it comes to prepaid credit cards, picking a good card requires some research. You want to ensure you’re getting the card that’s right for you, especially since some cards may cost you more in fees in the long run.Additionally, you want to get a prepaid credit card that’s accepted by as many vendors as possible. The whole point of having a prepaid card is to use it, after all.Here are some questions to consider when you’re shopping for a prepaid credit card.
Do You Want an Open- or Closed-Loop Card?As mentioned above, chances are you want an open-loop prepaid credit card that can be accepted by the majority of retailers. Look for a card that’s issued by a major brand, such as Mastercard, Visa, Discover or American Express.
How Do You Add Funds to the Account?It’s also important to scope out how you’ll add funds to the account, as different prepaid cards have different policies and requirements. For example, you may be able to initiate a bank transfer or direct deposit — but if you don’t already have a bank, or a job that offers direct deposit, that probably won’t be much use to you.You may also be able to load cash onto the card, or cash a check onto a prepaid credit card, but keep in mind that some prepaid cards charge fees for this.
What Are the Fees?They may not be charging interest, but prepaid card issuers are generally still interested in earning money. Often, you’ll find yourself on the hook for miscellaneous fees when opening a prepaid credit card account. The good news is, there are cards out there that charge very low fees, or that eliminate most fees entirely.Common fees to watch out for when opening a prepaid credit card include:
If you do find a card that doesn’t assess many (or any) fees, it’s still important to read the fine print. For example, you may be able to skip out on monthly fees, activation fees or fees to reload your card with cash, but you’ll have to pay a fee if you want to make a mobile check deposit.Recommended: Guide to Opening a Bank Account Online
- Activation or purchase fees
- Monthly maintenance fees
- Inactivity fees
- Reload fees
- Card replacement fees
- ATM fees
- Overdraft fees
- Customer service inquiry fees
Some Common Prepaid Credit CardsWhile there are many prepaid credit cards on the market right now, here are a couple of the most common.
Visa Prepaid CardsVisa offers a variety of prepaid card products, including the Netspend® Visa® Prepaid Card and the Green Dot® Prepaid Visa® Card, neither of which assess an activation fee if you sign up online.
Mastercard Prepaid CardsMastercard also offers a suite of open-loop prepaid credit cards, such as the H&R Block Emerald Prepaid Mastercard, which allows you to manage your funds from a convenient mobile app, as well as their own version of the Netspend Prepaid Card, which doesn’t carry a minimum balance requirement or any activation fees.
American Express Prepaid CardsAmerican Express offers several prepaid. One of the Serve® American Express® Prepaid debit cards allows you to do cash reloads for no fee, while another offers the chance to earn cash back.
Prepaid Credit Card AlternativesWhile prepaid credit cards do have their uses, there are also alternatives to consider.For example, if you’re really hoping to get started on building credit with a credit card, but your credit isn’t strong enough to qualify for most traditional cards, you might think about opening a secured card. Like a prepaid credit card, you’ll have to put down some money up front for a secured card — but unlike a prepaid credit card, a secured card does actually offer you a line of credit; the money is just a deposit. That means you’ll have the opportunity to build your credit by using a secured card (though like a regular card, you can also accrue interest charges and go into debt). You can compare credit builder credit card options to find one that suits your needs.Other alternatives to prepaid cards include:
- Money orders
- Debit cards linked to a bank account
The TakeawayPrepaid credit cards can be a helpful tool for those who need access to plastic without a bank account or the potential to go into debt. However, they can’t help you build your credit score, which is important for accessing loans and lines of credit. Upgrading to a secured credit card, or a card specifically built for applicants with lower credit scores, could help you get the financial access you need while also potentially helping you build credit over time.If you feel ready to start building your credit history, it’s important to shop around the various options on the market, considering interest rates and fees before applying. Fortunately, Lantern makes it easy to compare cards before applying, so you can quickly and conveniently see all your options.
Photo credit: iStock/Eva-Katalin
About the Author
Jamie CattanachJamie Cattanach is a full-time freelance writer whose work has been featured at CNBC, Yahoo Finance, The Motley Fool, the Huffington Post and other outlets. At SoFi, she writes about investing, retirement, student loans and how to get your money right -- no matter what that means for you.