If your credit history is suffering and you’re looking for a credit card solution, you may consider a secured credit card or prepaid cards Both are commonly advertised for people with new or troubled credit, but which one of the right one for you? The answer depends on whether you need to build up your credit or simply make electronic payments.
Both secured credit cards and prepaid cards require you to deposit money before you can start making purchases. Both can be used in most of the same places that credit cards can be used, e.g. grocery stores, gas pumps, etc. But, that’s where the similarities end.
How Secured Credit Cards Work
A secured credit card requires you to make a security deposit against the credit limit before you can be approved for the card. Your security deposit is placed in a savings account or certificate of deposit (CD) and kept there until your card is converted to an unsecured credit until you default on the credit card (hopefully you never do).
Applying for a secured credit card is just like applying for a regular credit card. Many card issuers still check your credit history, but you're more likely to be approved even if you have a bad credit history. When you use a secured credit card, you're borrowing money, just as with a regular credit card. Purchases made with a secured credit card go against your revolving credit limit and you're required to make regular monthly payments on your credit card balance.
Paying off your balance on a secured credit card frees up available credit that you can re-use, just as with a regular credit card. The security deposit is simply held as collateral.
How Prepaid Cards Are Different
You can swipe a prepaid card to make purchases, but what happens behind the scenes is a little different. Though they’re sometimes called prepaid credit cards, they’re not credit cards at all. Instead, prepaid cards more akin to debit cards, which are tied to a checking account.
There’s no credit limit for a prepaid card. Your deposit is placed into an account as a funding source for your purchases. When you make a purchase using your prepaid card, instead of borrowing money from the credit card issuer, the purchase amount is deducted from your card balance. Once you spend up to your deposit, you must redeposit money before you can spend again.
Prepaid cards eliminate the need to make monthly payments, which frees you from late payment penalties and credit damage. And since there's no credit check, you won't be turned down because of a bad credit history.
Secured Credit and Prepaid Card Fees
Fees vary between secured credit cards and prepaid cards. A secured credit card might carry fees typical of a credit card: application fee, annual fee, finance charge, and late fee. While some of these fees are required, others can be avoided depending on how you use your credit card.
Prepaid cards have entirely different fees and, depending on the card you choose, some of them can be high. Activation fees and monthly maintenance fees are charged the first time you open your account and each month the account is open. You may have to pay a fee to reload money onto the card, to withdraw money from an ATM, or to use bill pay. There are some prepaid cards that are completely free. There are no interest charges or late fees with a prepaid card.
Which Option is Best?
If you want to improve your credit score, a secured credit card is the best choice. Make sure you choose a secured credit card that reports to the three major credit bureaus. With some credit card issuers, you may become eligible to convert your card to an unsecured credit card after a period of timely payments.
A prepaid card is the ideal option for someone who is unable to open a checking account, e.g. because of a bad banking history, or who simply wants to avoid banks. Many employers can direct deposit your paycheck onto a prepaid card and some prepaid cards even let you send a few checks each month or enroll in online bill pay. Prepaid cards also offer a convenient option for teenagers and students to receive an allowance from their parents.