A 2014 survey by the Pew Charitable Trust found that 5 percent of American adults use prepaid cards—that’s roughly 12 million people! For the record, these aren’t gift cards that we’re talking about. In the Pew survey, “prepaid card” refers specifically to prepaid debit cards.
The term “prepaid card” (or “prepaid credit card”) is also sometimes used to describe a secured credit card. Secured credit cards are completely different than prepaid debit cards. However, both cards require initial payments, which is why you might hear the term “prepaid” applied to either.
Both cards maybe good solutions for individuals trying to practice fiscal responsibility.
Let’s discuss the difference between a secured credit card and a prepaid debit card, so that you can choose the best option for you this year:
- Types of Prepaid Cards
- Choosing Between a Secured Card and a Prepaid Card
- What to Look For in a Card
- Popular Prepaid Cards
What’s the difference between a secured credit card and a prepaid debit card?
Each card works in an entirely different way and each might be better suited to different financial circumstances and goals. Let’s explore in further detail.
Secured Credit Card
How does it work?
A secured credit card is not altogether different than a standard credit card. When you open a secured card, you’ll be opening a line of credit just as you would with a credit card. The difference—as its name implies—is that a secured credit card has a safety mechanism for the bank.
When you open a secured card, you’re required to pay a certain amount of money to a collateral account. You make this security deposit when you open the card. If you default on a payment, then the bank can use that deposit to settle your debt. It’s important to note that the security deposit is not actually used for making purchases. The money is set aside exclusively for the bank to use if you default on your debt.
Most secured cards require a security deposit of at least $200, but they can range higher. Your monthly credit limit is usually set at the amount of your deposit (for example, if you deposit $200, then your monthly limit might be $200)—but the credit limit could also be higher than your deposit on some cards. Just like with a standard credit card, you can be penalized for going over your credit limit.
In addition to the originating payment, cardholders must also make monthly payments to settle their balance. Lenders will make monthly reports to credit agencies, so your credit score may be positively or negatively affected depending on your credit behavior.
Who’s it for?
How did secured credit cards come into being? Well, they were designed as a tool to help those who have either a poor credit history or little credit history. If you have a low credit score or poor financial history, then you might have a difficult time getting approved for a credit card. That may result in a financial catch-22; after all, you can only build your credit score through responsible usage of a credit card. But how can you do that when you can’t even get approved for one?
Some consumers might not get approved for a credit card because their credit history is too short, and a secured card might be a good way to lengthen it.
Borrowers who have poor or little credit history are considered more at risk of defaulting on a loan, so that’s why a secured card requires a security deposit to protect the bank’s investment.
A secured card could be considered a proving ground for consumers who wish to prove their credit trustworthiness, and their readiness for a larger revolving line of credit. Indeed, some secured credit lenders allow consumers to upgrade their secure credit card to a standard credit card after a period of responsible debt repayment (typically a year).
Prepaid Debit Card
How does it work?
A regular debit card is linked to a checking account, and so each transaction it makes pulls money directly from that linked account. The difference between a debit card and a prepaid debit card is that a prepaid card does not have to be linked to a checking account. Instead, money is “loaded” onto the account. Money can be loaded via cash or check, or it can be transferred from another bank account.
A prepaid debit card can only use the funds that are loaded on it; if you load $200, you’ll only be able to spend up to $200. Unlike a secured credit card, a prepaid debit card won’t be able to make any more transactions once its funds are depleted. In that respect, it might be compared to a gift card. Some prepaid debit cards are reloadable, while others are not.
Who’s it for?
A prepaid debit card is optimal for consumers who are trying to control their budgeting; in fact, the abovementioned Pew survey found that spending control is one of the top reasons consumers use prepaid debit cards. Some consumers try to budget themselves by limiting their spending to a pre-ordained amount of pocket cash. You can use a prepaid debit card to do the same thing. A prepaid card can help you segment your funds and make available only the amount of money that you want to use.
A prepaid debit card is also an excellent option for travelling. If your credit or debit card is stolen, your bank accounts may be vulnerable, and you also might be have no other way to access funds. A prepaid debit card is a much better card to have stolen (we know that sounds a bit silly). A stolen prepaid card won’t provide access to your bank accounts, and some cards even have fraud protection.
Choosing Between a Secured Card and a Prepaid Card
So what’s better: a secured credit card or a prepaid debit card? In truth, one is not better than the other. It really depends on what your financial situation is, and what you’re looking for out of a card:
If after looking at your free credit report you’ve found you need to start building credit, then you might prefer a secured credit card. A secured credit card grants you a line of credit, and, thus, the opportunity to boost your credit score. If you’re new to the world of credit, know that paying your balances on time (and, preferably, in full), can have the most positive influence on your credit score—see our guide, for more details. Having a secured card alone will not immediately place you in good credit standing; you’ll have to practice responsible credit behavior.
Typically, secured credit cards are sought after by consumers who can’t get approval for a standard credit card, either due to poor credit history or sparse credit history. If you have a fair credit history, you might consider looking into opening a standard credit card, first. A standard credit card may give you a much higher credit limit than a secured card, and standard credit cards are typically viewed as more prestigious—both of these aspects factor into your credit score. If building credit is a priority for you, you might want to apply for a standard credit card before you apply for a secured one.
If you can’t get approved for a credit card, then a secured line of credit may be an effective way to build your credit score. Remember, some lenders may allow you to upgrade your secured card to a credit card if you can prove yourself capable of paying your card balance each month.
A prepaid debit card does not grant you any line of credit, so it will not affect your credit score whatsoever.
If you’re interested in a prepaid card because you’re trying to budget your spending, then either a secured credit card or a prepaid debit card may be suitable for you.
With a prepaid debit card, you can load your allocated budget onto the card so that you’ll only be able to make your budget’s-worth of transactions. You won’t have to worry about overspending because the card won’t be able to make transactions once you’ve spent all of its funds (a secured credit card, on the other hand, may allow overdrafts).
Prepaid debit cards are enjoyed by consumers of many different financial standings. The Pew survey indicated that even consumers with bank accounts, credit, and high-income used prepaid debit cards because of their helpfulness in budgeting.
But a secured credit card may also be optimal for budgeting. A secured card typically has a lower credit limit than a standard credit card. The lower credit limit may entice you to limit your spending so you won’t be penalized.
If you already have a credit history, opening a secured credit card may positively affect your credit score because it would increase your overall available credit. Be cautious, though: opening any line of credit—including a secured credit card—will cause your lender to make a hard inquiry. Hard inquiries may briefly drop your credit score by a few points.
Some consumers try and keep their personal finances away from banking institutions. Many don’t want to pay the rates and fees required to maintain bank accounts.
You might prefer a prepaid debit card if you don’t want to have a checking or savings account, or if you simply want a card that doesn’t pull funds directly from your bank account. You might also find prepaid debit cards preferable if you don’t want to navigate the world of credit.
While a prepaid debit card may help you avoid bank account maintenance fees, be advised that prepaid debit cards typically have their own high rates and fees. Many prepaid cards have monthly or annual fees, and may charge for ATM withdrawals or online card management. Since there’s no interest to be collected, issuers use these fees to turn a profit.
What to Look For in a Prepaid Card
When you’re shopping around for a secured credit card or a prepaid debit card, there are certain aspects of each that you’ll want to take into consideration.
Secured Credit Card
Deposit and Credit Limit
As we discussed earlier, the security deposit is one of the signature features of a secured credit card. We also mentioned that many lenders set the credit limit at whatever amount you deposited.
Consider choosing a secured card that has an appropriate credit limit for your desired spending. If you only need to make small purchases, you may want to find a card with a smaller deposit and lower credit limit. If you need to make larger purchases, you may prefer to find a card with a larger deposit and higher credit limit. Just remember that with secured cards, your credit limit will probably not be as high as that of an unsecured credit card.
Regardless of your desired credit limit, you should be aware of credit utilization ratio. Read this guide if you’re unfamiliar with credit utilization. In a nutshell, aim to use as little of your available credit as possible—below 30% is the general rule. So, if your credit limit is $200, you may want to keep your credit purchases below $60. Keep this in mind when you’re evaluating a card’s credit limit.
Some secured credit cards carry an annual fee. Typically, the annual fee is between $25 and $50. It’s not a bad strategy to seek out cards that have no annual fees. Bear in mind, though, that a card lacking an annual fee is not necessarily better than a card with an annual fee.
In addition to an annual fee, some cards may also charge fees on foreign transactions, and there might be a few “hidden fees” that’ll add to your monthly payments. Consider opening a card that has fewer fees.
Annual Percentage Rate (APR)
Annual percentage rate (APR) is a term that you’ll frequently see attached to any loan. Whenever you don’t pay your card’s monthly balance in full, you’ll have to pay interest on the remaining balance. APR calculates what percent interest you pay on remaining balances.
APR may range anywhere from 10% to as high as 24.99%. Some cards may grant you a lower APR for the first 6 months, and then it increases.
Cards may have two different kinds of rates: a fixed-rate, or a variable rate.
If you open a fixed-rate card, then your APR should remain the same the entire time you hold the card, no matter what.
Variable rates may change over time. Most variable rates correlate with a benchmark “index rate” that’s determined by the government and/or large banking institutions. If the index rate increases, the variable rate of your card will increase, too. Fixed-rate cards are not linked to and will not be affected by changing index rates.
While it appears that there’s a lot of uncertainty that comes with a variable rate card, it should be noted that—regardless of whether you have a fixed-rate or variable rate card—you won’t have to pay APR at all so long as you pay your monthly balances in full.
- 10% variable rate + All Monthly Debt Paid = $0 Interest Expense
- 99% fixed rate + All Monthly Debt Paid = $0 Interest Expense
APR does matter; in a circumstance where you’re unable to pay your monthly debt, it would be nice to have a low APR that doesn’t add so much to your existing balance. But many consumers—with the goal of building their credit—only use secured cards to make small, manageable purchases that can easily be paid in full. If that’s your goal, a high APR might not dissuade you from selecting a particular card.
Many consumers who use secured credit cards hope that with responsible usage, their card will be graduated to a standard, unsecured credit card. If you’re looking to build your credit score and eventually open an unsecured card, consider seeking a secured card that allows you to graduate it.
Even if your secured card can’t be upgraded, it could still be a stepping stone toward acquiring an unsecured credit card. If you’ve managed the card responsibly for some months, you could apply for a credit card if you think that your credit score has improved—a credit monitoring agency can help you monitor your credit changes. Again, bear in mind that the hard inquiry might temporarily drop your credit score by a few points.
Not many secured credit cards offer rewards, but they do exist. And, if you’re on a tight budget and you’re looking for ways to save money, these cards might be a good option for you.
Some cards offer cashback rewards for transactions (that’s when you receive a small percentage of the transaction price as reward for using the card). Cashback rewards typically won’t be as lucrative on a secured card as they’d be on an unsecured card or a store credit card. Nonetheless, they may save you money over time if you make frequent purchases.
Some secured credit cards cards may only be available for consumers with better scores, and acquiring one may require a hard credit check. Other cards are available for almost everyone and don’t require a credit check at all.
If your credit standing has been severely damaged, consider seeking a card that doesn’t require a credit check. These cards may help you improve your credit score and better your financial standing.
If you have some credit history already, you may want to think twice before applying for a secured card that requires a credit check. If your credit score is needed in the near future—for example, if you’re moving into a new apartment—then a hard inquiry may drop your score by a few points.
Prepaid Debit Card
There are prepaid cards available that are not reloadable. Non-reloadable cards might be good for travel. If you only plan on using your prepaid card for a short time—a quick vacation, perhaps—then you might seek out a non-reloadable prepaid card. You can load it with a high amount of funds, and you can easily dispose of it after your trip.
If you’re trying to get more mileage from your card, then you might prefer a prepaid card that can be reloaded.
Fraud and Purchase Protection
If you plan on using a prepaid debit card for travelling, or if you’re going to load a high amount of funds onto your card, you should consider seeking a card that’s covered by fraud protection. Fraud protection will protect you in case your card gets lost or stolen.
Some cards also have purchase protection. Purchase protection refunds any of your purchased items that have been accidentally lost or damaged. It’s a good feature if you’re going to use your card to purchase retailed or online goods.
Prepaid debit cards may come with a variety of fees, including:
- Foreign transactions
- ATM withdrawals
- Monthly maintenance
- Cash reloads
Consider shopping for a card that has less and lower fees.
Reward programs can be a major draw of prepaid debit cards.
Some prepaid debit cards offer cashback programs. This is not the same cashback program that you’ll find available on debit cards (that program allows users to make cash withdrawals during a transaction). This is the credit card-style cashback program where you can earn a percentage of the transaction price.
Some cards may require you to pay a minimum amount in purchases before you can earn cashback rewards. Other cards do not.
Some prepaid debit cards allow you to transfer funds to a special savings account. This feature might be helpful if you’re trying to save money, but don’t have a traditional bank savings account.
Some consumers may be concerned about which brand the card is serviced by (“should I buy a prepaid Visa or a prepaid Mastercard?”). Most major service brands—Visa, Mastercard, Chase, American Express, etc.—perform many of the same functions. It’s likely more important to pay attention to the specific card you’re prospecting and what its features and specs are. It’s likely you’ll find similar cards across most of the different service brands.
Popular Prepaid Cards
Now that you know how to choose the right secured credit card or prepaid debit card, it’s time to get to work.
If you’re interested in a secured credit card, you might try this search engine created by credit bureau TransUnion.
If you’re more interested in a prepaid debit card, Forbes has compiled a small list of cards that might be a good starting point for you.
Happy card hunting!