Editorial Policy

Secured Credit Cards Vs. Prepaid: Which is Best?

Eva Norlyk Smith Ph.D.

January 25, 2012

If you have applied for a credit card and been denied because you have bad credit or no credit history, don&#039t lose heart. You still have options.

There are two main types of plastic available for people in this situation: secured credit cards and prepaid cards. Both have advantages and drawbacks.

Secured credit cards
As the name implies, the credit line on a secured credit card is backed by a deposit you make in an account linked to the card. Once a deposit is made, you can use a secured credit card just like any other credit card — charging purchases to the card and paying monthly bills.

The security deposit is drawn down only if you fail to pay the credit card bill on time and as agreed. In addition, if you maintain a regular payment history, the card issuer will typically reward you by increasing your credit line without requiring you to add to your security deposit.

Pros: The monthly bill payments made on most secured credit cards are reported to the credit bureaus. For this reason, a secured credit card can help you build a good credit history — as long as you pay the bills on time.

Cons: The main disadvantage of secured credit cards is the cost. Because these cards cater to higher-risk consumers, most issuers of secured cards charge higher fees and interest rates. By law, the opening fees are limited to 25 percent of the available credit limit during the first year. This means that, for an initial $200 credit line, a secured card would come with a $50 opening fee, leaving you with $150 in available credit. These “minimum security deposits” vary and are sometimes refundable when you close the card with a $0 balance. Read the terms and conditions of each card carefully before apply.

Watch out: Avoid online credit card applications that don&#039t enable you to see the card terms and conditions until you&#039ve gone through the application process. They are likely to hide sneaky terms, like charges for increasing your credit limit or high annual fees. Also watch out for secured credit cards with high interest rates. Some can sport interest rates as high as 49.99 percent.

Best bet: Capital One Secured MasterCard. For a modest $29 annual fee, you can get a $200 credit line backed by a $49 deposit. If you deposit $99 or $200, you may qualify for a higher credit line, up to $3,000. The card&#039s annual percentage rate (currently 22.9 percent) and other fees are comparable to other bank credit cards, which is unusual for a secured credit card.

Prepaid cards
Prepaid cards look like and are used just like credit cards, but they function more like debit cards. Your credit line depends on how much money you have loaded onto the card, and each time you make a purchase, you draw down those funds. In other words, with a prepaid card, you don&#039t have access to a line of credit. You can spend only the money you put into the card account.

Pros: It&#039s easy and fast. Anyone can get approved for a prepaid card. There are no credit checks and no lengthy application processes.

Cons: Prepaid cards have two main drawbacks: They come with a multitude of fees, and they don&#039t help you build a credit history.

Prepaid cards have been criticized, not just because they charge a wide variety of fees, but because the pricing and structure of most prepaid cards makes it difficult to determine how much it will cost you to use them.

“The fees associated with these cards resemble a mine field where the wrong step by the cardholder could result in monthly fees greater than $30,” says credit expert John Ulzheimer in an emailed statement. “This is well in excess of any fees being charged by banks for properly managed checking accounts.”

Watch out: Never get a prepaid card without carefully reading the terms. Most not only feature a monthly fee (typically $3 to $5), but also charge extra for ATM withdrawals, customer service calls, paper statements and, in some cases, for loading money onto the card.

Best bet: For an (almost) fee-free prepaid card, check out the American Express Prepaid Card, which charges only one fee: $2 for ATM withdrawals (you get one free withdrawal a month). Cardholders are automatically enrolled in Amex&#039s Make Your Move program, which means that, if you develop a good track record with the card, you may be invited to take another step up the credit ladder and apply for an American Express Charge Card.

The bottom line
If your main purpose is to rebuild credit, a reasonably priced secured credit card will be your best choice. It gives you a chance to use credit and build a history of regular payments.
“You have to use credit to rebuild credit,” says Melinda Opperman, vice president at Springboard, a nonprofit consumer credit management service. “And credit-building is so important. Your credit score is like your financial DNA. It determines your financial success in life in so many ways.”Th_prepaid-secured