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What is a prepaid card and how does it work?

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A prepaid card is a great option if you are just starting to build your credit and worry you won’t qualify for an unsecured credit card. Due to the fact that they don’t require a credit check, prepaid cards make it possible to use plastic even if you don’t have a formal credit history. Prepaid cards are typically a popular choice for college students and other young adults who are trying to establish strong financial habits without taking on the financial responsibility that comes with most unsecured credit cards. Keep reading to better understand what a prepaid card is and how it works.

What is a prepaid card?

Much like a debit card, a prepaid card is a card that can be used to make purchases. It is loaded with a balance ahead of time, and this balance acts as your spending limit. The prepaid card can then be used in place of a credit card for payment, but unlike a credit card, the prepaid card won’t build up any debt or incur interest charges. Instead, the prepaid card can only be used for spending the money you already have.

A prepaid card is a good idea if you want a credit card but you don’t want to risk getting into debt. A prepaid credit card won’t boost your credit score, but it can come in handy for making online purchases or paying bills by mail. Many people also use prepaid cards as a way to teach their children how to manage money.

Prepaid cards vs. debit cards vs. credit cards

When looking at prepaid cards, comparing them to credit cards or even debit cards can be a bit difficult. A prepaid card can do many of the same things as a credit or debit card, but in many ways they’re different.

Unlike debit cards, prepaid cards aren’t linked to a bank account. And unlike credit cards, prepaid credit cards do not come with a line of credit. Prepaid cards are issued by banks and financial service companies, but they are not connected to a line of credit or regular checking account. Instead, you only have access to the money you have loaded onto it. You aren’t borrowing money or paying a deposit that acts as collateral.

The pros and cons of prepaid cards

A prepaid card, for the most part, functions like any other card. You can swipe it or insert it at most point-of-sale systems to make a purchase. So, you may be wondering what is the point of a prepaid card when most people could simply pay with cash. Such is life, there are pros and cons of prepaid cards that are worth considering. Let’s take a look at a few:

Pros of a prepaid card

A prepaid card is more accessible than a credit card

If you think you’re not likely to qualify for a credit card, a prepaid card is probably the way to go because you don’t have to worry about qualifying for a specific card. The prepaid card issuer grants you access to the card without checking your credit history.

It can provide a safety net

If you’re concerned about having money in an emergency, a prepaid card can be an easy way to safeguard it. With a prepaid card, you can easily monitor your balance, and if you need more, you can load more money onto the card.

You won’t have to worry about overspending

Many of us are susceptible to offers and special deals. While that may be a good thing because it means you’re taking advantage of all the opportunities for savings, it can be a challenge to avoid overspending. That’s where a prepaid card, with its set spending limit, comes in handy. No matter how many offers you get in the mail, you’re not going to be tempted to overspend with a prepaid card. You can only spend what you’ve already loaded onto the card, so you won’t wrack up debt on an impromptu shopping trip.

You don’t have to worry about missing a payment

While traditional credit cards can be convenient, they can also be a liability. With a prepaid card, you can take advantage of the convenience of plastic without the risk of taking on more debt than you can pay off. You can shop with a prepaid card virtually anywhere and you don’t have to worry about paying your credit card bill and potentially making late payments.

A prepaid card is less stressful to carry around

If your prepaid card is stolen, the thief will only have access to the amount loaded onto the card and not an entire checking account, as is the case with a debit card. And while most credit cards have zero fraud liability, fraudulent credit card charges can still wreak havoc on your credit.

Cons of a prepaid credit card

Fewer consumer protections

Prepaid cards come with fewer protections than your average credit card. In 2019, the Consumer Financial Protection Bureau added comprehensive consumer protections for prepaid accounts, including protections in case of errors, loss or theft, and stricter rules for issuers when it comes to relaying clear information regarding prepaid account fees. While this is a step in the right direction for consumers who already hold prepaid cards, these protections don’t exactly compare with those of traditional credit cards.

It won’t impact your credit score

When you use a prepaid card, you aren’t borrowing money, so any activity is generally not reported to the three credit bureaus. Prepaid cards don’t offer you the same protections as credit cards, but they can still help you with your credit goals by inspiring financial habits such as only spending what you currently have. If your goal is to improve your credit score without committing to an unsecured credit card, you may want to consider becoming an authorized user on someone else’s card or applying for a secured credit card.

Lingering fees can add up

Before committing to a prepaid card, be aware of any fees that come with it. Some prepaid cards may charge cardholders fees for withdrawing cash, reloading a card, checking the balance or even making purchases.

Alternatives to prepaid cards

Not everyone is comfortable with the idea of a prepaid card, especially those who want a card with a credit line or a boost to their credit score. However, there are other options that are specifically designed for people with bad credit or no credit at all.

For starters, a secured credit card is a solid alternative. Secured credit cards are credit cards that require a cash deposit as collateral. Your credit limit is often equal to 50 percent to 100 percent of the amount of the initial deposit. Consumers with poor credit tend to lean toward secured credit cards because they give consumers the opportunity to build credit by practicing good credit habits.

One of the biggest advantages of a secured credit card, especially as a beginner card, is that the card issuer reports your credit information to the three credit bureaus. This allows you to build a positive credit history once you start making regular purchases and paying them off on time. These cards tend to be better for your credit than prepaid cards, but there are some drawbacks to keep in mind. Like most credit cards, be aware any fees you may face with a secured credit card, such as annual fees or processing fees.

Another option is to apply for an unsecured credit card for consumers with bad credit. Don’t be discouraged if your credit score is bad, as there are plenty of credit cards that you can apply for without paying a deposit upfront.

Keep in mind that a hard inquiry appears on your credit report every time you apply for a new credit card, which results in a temporary ding to your credit score. That’s why it’s important to research credit cards ahead of time and only apply for the card that will best meet your financial needs.

The bottom line

There are many reasons to apply for a prepaid card, especially if you are rebuilding your credit. For instance, a prepaid card can help you make purchases without overspending. But prepaid cards are not for everyone—they don’t help you improve your credit score, nor do they offer the same consumer protections as credit cards. If you are trying to rebuild your credit, be sure to apply for the card that best fits your needs.