Editorial Policy

Prepaid cards are not a credit solution

Erica Sandberg

January 2, 2015

QHi Erica,

I don't have good enough credit to get a credit card (my score is in the 500s), but I really like the convenience of cards. What should I know about prepaid cards before I pick one? Are there fees? Are some better than others? Help! –Tracy

ADear Tracy,

As you may know, prepaid cards are not credit cards, but accounts that you load up with your own funds. The issuer doesn't lend you money, but facilitates your transactions. Consequently, your credit history and scores are irrelevant and are not checked. Anyone can get a prepaid card — no matter the person's age, employment status, credit performance or current debt load.Ask Erica

What really is this thing you're getting? A piece of plastic that resembles a debit or credit card. Most sport the Visa or MasterCard logo, though American Express issues some, as do a variety of banks, credit unions and retailers. You can use a prepaid card just about anywhere credit and debit cards are accepted. It eliminates the need to carry large rolls of bills for big shopping sprees, so it's convenient and safe. You won't be out the value of the card if it's lost or stolen, as long as you contact the issuer immediately and are able to provide them with the account number.

However, almost all of these cards are fee laden. For example, the issuer may charge up to $20 to start the card, plus more on a monthly basis to keep it activated. Each time you reload the card or pay for something, more fees could be deducted from what you deposit. If the card is lost or stolen, a replacement might cost you further.

How much exactly it takes to open, use and maintain such a card depends greatly on the issuer, but the terms should be clearly spelled out on the paperwork or website. Read the offer carefully, but don't hesitate to give them a call if you're unsure. You wouldn't be out a huge amount of money if you open an especially expensive card by mistake, but it makes no sense to waste even a dollar if you don't have to.

Frankly, unless the fee structure is very low, I'm not a fan of prepaid cards. If you have a debit card from your bank that's attached to your checking account, that should suffice. Debit cards have few (if any) extra fees and you won't have to keep filling the darn thing up before the cash value runs out. Just make sure you opt out of overdraft protection, because if you go over your balance, the fees can add up.

What you don't get with either prepaid or debit cards is the opportunity to create or mend a credit reputation. Since you're not borrowing money, the issuer won't send the card's activity to the credit reporting agencies. Because your scores (which I presume are FICO, the most common scoring model) are so poor, you'll probably want to bring them up. If you do, you'll be more eligible for the better, less costly credit products on the market today. The only way to do so is by letting old, negative information age off the reports while adding new, positive data to them. That means using a credit card or taking out a loan, as that activity will be listed and factored in to your scores.

Even with numbers as low as yours, you may qualify for a secured credit card. Typically, all you need are a couple of hundred dollars to put down as a deposit with the issuer to hold as collateral, plus a steady income. You'll get the money back when you close the account and it's at a zero balance. Most come with annual fees of about $30, but that's about it. The APRs tend to be higher than unsecured accounts, but if you pay in full and on time each month, which I recommend, who cares? Make sure the card issuer reports your activity to the three major credit bureaus, TransUnion, Experian and Equifax, so that your good behavior is reflected on your credit reports.

By charging responsibly for about a year or so, you'll almost certainly increase your scores enough to obtain a fee-free unsecured card.

There is also the possibility of getting on another person's account as an authorized user. It's easy to get on or be taken off, unlike co-signing, and if the primary cardholder is responsible with the account, that positive payment history should boost your credit.

That said, I'm not pushing you into a credit card of any kind. It's just important to be aware of all your options. Clearly there is a multitude of ways to pay with plastic. Choose and spend wisely.

Got a question for Erica? Send her an email.