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Pick a card: Secured credit cards vs. prepaid cards

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Say you want to tighten up your spending and control debt, and you're eyeing either a secured credit card or prepaid debit card.

After all, these two types of cards have striking similarities. You can't rack up debt because your spending is limited to the amount of cash that backs up your card. And secured cards and prepaid cards are widely available from banks, credit unions and credit card companies. Yet, choosing the wrong card can ding your financial well-being.

Why? For starters, only secured cards can help you improve your credit score. "They help you build or establish credit," says Greg McBride, CFA, chief financial analyst at Bankrate.com. "That's why people get them."

Secured vs. prepaid cards: The basics

After all, secured credit cards are much like regular credit cards, except that you must make a security deposit before using the card, usually $300 to $500. Then, your spending is limited to the amount of money that you've deposited as collateral. Each month, you make payments on the amount you owe.

Conversely, reloadable prepaid cards resemble bank debit cards, except that you can use only the amount of money that you've loaded onto your card. So, $300 loaded onto your prepaid card gives you $300 in spending power.

"Both cards also have a range of choices," says Christina Tetreault, staff attorney on Consumers Union's Financial Services Program team. "Some cards are terrific, and some are crummy."

Before applying for these or any other type of credit card, check your credit score at myBankrate.

Improving credit score with secured cards

Because issuers report payments to credit bureaus, secured credit cards can quickly improve your credit score. And sometimes you can get bumped up to an unsecured card as your credit improves when you pay your bills in full and on time for about a year.

"So, they're a great way to establish credit or get back on track with credit reporting," Tetreault says. But make sure the card reports to all three credit bureaus: Experian, TransUnion and Equifax.

Though these cards seem straightforward, people mistakenly think that their monthly payments will be paid from their security deposit, says Lee Gimpel, director of development for LifeWise Strategies of Wilmington, North Carolina. "But that deposit actually stays active until you close your account," says Gimpel. "So your money is effectively tied up, since you pay off the bill like a regular credit card."

And minimum payments, even on secured cards, can end up costing you. Interest rates can be as high as 28 percent on unpaid balances, says Andrea Luquetta, a policy advocate at the California Reinvestment Coalition in San Francisco. Meanwhile, your security deposit is reaping only small interest rates.

Control spending with prepaid cards

Conversely, prepaid cards are increasingly used to control spending, so some prepaid cards are bolstering their budgeting features, according to a 2014 Pew Charitable Trusts study. For example, one prepaid card company lets you pay bills online, see real-time balances, get text alerts and even set savings goals.

That's why some prepaid cards are terrific for budgeting, Gimpel says. "You can use one card for food purchases and another one for gifts," he says. "Prepaid cards are an electronic version of the popular envelope budgeting system." In that method, a person puts cash into labeled envelopes to pay a certain expense.

Tetreault says that some prepaid cards are even linked to savings accounts with interest rates of more than 3 percent.

On the downside, some prepaid cards, such as the Suze Orman and Magic Johnson cards, have folded recently. "So, go with an established bank or other financial institution and not with a celebrity card," says Luquetta. The reason: No federal laws or regulations protect consumers when prepaid cards fail, according to Pew Charitable Trusts.

As always, fees matter

Secured credit cards are usually bare-bones offerings, says Gimpel, but they may have a variety of fees that regular credit cards don't have. For example, some secured cards may have balance transfer fees or even cash advance fees.

So, Consumers Union's Tetreault says to look for secured cards with no monthly or annual fees. There shouldn't be special fees such as application fees that can "nickel-and-dime you," she says.

"Some terrific cards are available through local banks, credit card providers and credit unions," she says. For example, Kirtland Federal Credit Union in Albuquerque, New Mexico, offers a secured credit card with no annual fees or over-limit fees.

Stick with cards offered by larger issuers and you'll be safer, says Bruce McClary, government relations and public policy manager in the ClearPoint Credit Counseling Solutions' Seattle office.

"Lots of fringe issuers have questionable offers and may not be competitive," he says. "The lowest interest rates are offered to people with a good credit history, though." Compare a few different offers before signing up, he adds.

Better services with secured cards?

Despite these warnings, LifeWise Strategies' Gimpel says you're likely to find better services with secured cards than with prepaid cards. "You can get points or cash back," he says. And some cards let you enjoy some of the same perks as credit cards, such as car rental insurance, purchase protection and travel accident insurance.

Tetreault says a secured card's biggest advantage is zero liability from fraud, experts say. "If you lose your secured card, you get the same protections as regular credit cards," she says. However, prepaid cards still aren't covered by federal laws, so protections vary.

Still, you should avoid costly add-on services such as credit protection. "They may not be what you need," McClary says.

Watch out for prepaid fees

Prepaid cards are notorious for their fees, including add-on fees, McClary says. However, some fees such as point-of-sale fees and customer service fees are going away, though monthly fees are increasing, according to the Pew report.

McBride explains that prepaid cards are increasingly transparent and have lower fees, including flat monthly fees that make figuring out monthly costs easier. Also, a number of the cards are offered by big banks, so you can use their bank branches and ATMs and avoid ATM charges.

"High-fee cards are becoming marginalized as prepaid cards become more consumer-friendly," McBride says.

Tetreault says the best prepaid cards also don't have overdraft features. "They're attractive for consumers with budgeting issues since you can't rack up debt," she says.

Ultimately, your best strategy is to shop around for the best type of card for you, Tetreault says. "Both cards have their pitfalls," she says.

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Editorial Disclaimer: The editorial content is not provided or commissioned by the credit card issuers. Opinions expressed here are author’s alone, not those of the credit card issuers, and have not been reviewed, approved or otherwise endorsed by the credit card issuers.

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