How Does a Prepaid Card Work?

Using Prepaid Cards as an Alternative to Traditional Credit Cards

Woman using credit card at laptop
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It's pretty easy to visually mistake a prepaid card for an actual credit card. For the most part, prepaid cards look identical to credit cards and can be used in most places that accept credit cards. For instance, you can use a prepaid card for car rentals, hotel reservations, airline bookings and various online purchases. 

You can get a prepaid card even if you have bad credit. However, as the name indicates, you can't use it unless you've prepaid money onto the card. Since this financial instrument doesn't actually allow you to carry a credit balance and pay later, it's not a true credit card. 

How Does a Prepaid Card Work?

With a prepaid card, you add money to it as you might with a gift card. Then as you use your prepaid card, the amount of your purchases is deducted from the balance. As you make more purchases, your available balance gets further reduced.

Let’s say, for example, you deposit $300 onto your prepaid card. After paying $150 for a car rental, you’d only have $150 left to spend. Once you’ve used your entire balance, you have to reload more money onto the prepaid card before you can use it again.

By comparison, a credit card gives you a credit limit that you can borrow against for purchases. You have the option of repaying your purchases with monthly installments, or all at once.

Managing your prepaid card resembles managing a checking or savings account more than managing a credit card. You don’t have to worry about finance charges or late payments. Your spending limit equals whatever dollar amount your card currently holds. You'll also have no increased revolving debt balance, minimum required payments or due dates to think about, and no risk to your credit score.

People might think of these cards as prepaid credit cards because most card companies use the Visa, Mastercard or American Express merchant payment networks and show the corresponding emblem on the face of their cards.

Actually, a prepaid card more closely resembles a debit card because all transactions reduce your cash balance, but instead of funds coming from a bank account, they come from funds you've previously deposited onto the card.

How Much Does It Cost?

Prepaid cards can come with a variety of fees. Before choosing a card, read the "fine print" and choose a card with the least amount of fees, so that they don't eat up whatever money you deposit to the card.

For example, the Account Now Prepaid Mastercard charges a monthly fee of $9.95, an ATM withdrawal fee of $2.50 per transaction, up to a $4.95 fee to reload additional funds to the card, $2.50 for each ACH transaction on your account, $1.50 to make a balance inquiry at an ATM and $1.00 for each monthly statement. Each time you incur a fee, it comes from your balance, giving you less remaining money to spend.

Since the cost plays a big role in the prepaid card you choose, make sure you pay close attention to the fee schedule of any card you're considering. Many, such as Bluebird by American Express or the Akimbo prepaid card, have no monthly fee and also keep other fees to a minimum.

Who Uses Prepaid Cards?

You might use a prepaid card if your bank doesn’t offer debit cards and you don’t have a traditional credit card, or if you can't get a checking account because you have bad credit with ChexSystems. ChexSystems monitors individuals' checking and savings account activity to alert merchants about people writing bad checks when paying for purchases. 

Children and college students also make good candidates for prepaid cards. Parents can load money on the card for their young kids to use, and begin teaching them good money management skills. For college students, parents can easily reload money onto the card allowing the students to pay for books, food, and ongoing expenses.

As prepaid cards become more popular, they're not just used by people with bad credit or those who can't get a checking account. Some people use prepaid cards to help manage their budget.

For example, you could load a set amount of money for clothes shopping, dining out or groceries onto a prepaid card to keep from overspending your monthly budget. Others opt for prepaid cards because they're tired of getting overdraft fees from spending without knowing their exact bank balance.

Will It Help Rebuild Credit?

You can get a prepaid card regardless of your credit history. Providers don't check your credit because you're not borrowing money, so prepaid cards won’t help you establish or improve your credit.

Using a prepaid card says nothing about your borrowing or repaying habits, so the card companies have nothing to report to the credit bureaus. In short, if you use a prepaid card, it won’t have any influence on your credit score, good or bad.

If you’re looking to rebuild your credit, consider a secured credit card as a better option. It’s similar to a prepaid card in that you have to make a deposit to get the card but it’s actually a credit card. The deposit acts as collateral in case you don’t pay your credit card balance, and your payment history gets reported to the credit bureaus.