The differences between secured credit cards and prepaid credit cards can be confusing. This confusion can lead to cardholders mismanaging their accounts and seeing their credit scores fall – or stagnate when they expect their scores to grow.
The difference between secured credit cards and prepaid debit cards lies in whose money you spend when using the card.
When you spend money with a secured credit card, you borrow it from the credit card company. This money is then reimbursed each month when you make your credit card payments.
When you spend money with a prepaid card, you spend your own money. Indeed, before you buy something, you must load money you already have onto the card.
Secured credit cards help you rebuild your credit
A secured credit card can help you build credit because it involves borrowing and reimbursing money to a lender, which is the issuer of the secured credit card. Prepaid credit cards, on the other hand, have no influence on your credit score because you are spending your own money rather than borrowing it.
Like any other credit card, a secured credit card works with one key difference. Secured cards require a cash security deposit — usually between $200 and $300. The deposit usually equals your credit limit, so you will have a $500 credit limit when you deposit, say, $500.
The most significant thing to understand is that the credit card company does not use this money to pay for your purchases. When you buy items with a secured credit card, you have to pay for them just as you do for a normal credit card when your statement arrives.
The deposit is there only in case you don’t pay your credit card bill. If this happens, the issuer takes the deposit to cover the amount you owe them (and possibly will also close your account).
Prepaid credit cards are like debit cards
A prepaid card also requires a deposit, but it is not a security deposit because it is used to pay for the things you buy with the card. The card company uses the money you load onto the card to pay for your transactions.
Say you load $500 onto your prepaid card then you've got $500 to spend when you use it. Once you have spent it, you can't use the card again until you put more money on it.
Secured credit cards can help you improve your credit score, while prepaid credit cards don't even show up on your credit report. Since secure credit cards consist of continuous credit card repayments, activity with secured cards is recorded by credit bureaus such as Equifax and TransUnion. You must ensure that your balance is less than 30% of your card limit and that payments are made on time every month.
On the other hand, prepaid credit cards are the functional equivalent of a debit card. The money on the card is your own to use however you wnt. You don't borrow, so there's nothing to report to the credit bureaus. Any kind of prepaid credit card will not affect your credit score.
Don't confuse prepaid with secured
Cardholders may be confusing the inner working of these different cards. Some people make a deposit on a secured credit card and think they spent money on the card. Here's an example:
If you put down a security deposit of $300, then make a $300 purchase but don't pay the bill back because you aren't even aware that you have to pay it in the first place. Your credit ends up suffering in several ways: by maxing the card, by missing payments and by getting your account closed by the issuer for non-payment.
Others get a prepaid credit card thinking that it's going to help them build credit. So they load money diligently on the card and never overspend. Yet their credit scores never go anywhere since no activity appears in their credit report.
Secured cards or prepaid cards: which one is right for you?
If you want to increase your credit score, get a secured card. Since your credit limit is the same as your security deposit, secured credit cards don't really provide you with additional “spending power.” The whole point of getting one is to show that you can handle credit responsibly. You can borrow money and pay it back, and you should keep your balance as low as possible – ideally paying it off in full every month. Do this, and your credit score will increase, as long as you make your credit card payments on time.
If you're looking for a tool to control your spending, get a prepaid credit card. They don't help you build your credit history, but prepaid credit cards can be invaluable as a budgeting tool or a convenient method of payment. Do you want to set a hard spending limit on things so you don't blow your budget? Put X money on a prepaid card each month and when it's gone, you're finished spending that month.