How Do Prepaid Credit Cards Work?

Nov 23, 2016 | Be First to Comment!

Prepaid credit cards

Prepaid credit cards look and work pretty much like regular credit cards once in the hands of cardholders. You can charge purchases to the card just like any other plastic. But the difference lies right in the name.

Before you use a prepaid card, you have to load money onto it. It works more like a debit card than a traditional line of credit. You spend your own money that you previously put on the card when you make a purchase.

Thinking about exploring this payment option and wondering if a prepaid card is right for you? You need to first understand exactly how they work -- and then look at your spending habits and how you plan to use your card. Read on to learn more about the pros and cons, as well as specific details on how they work.

Understanding Prepaid Cards and How They’re Different

Jorge Soriano, CFP, agrees that prepaid cards act like debit cards that have the added benefit of not allowing you to overdraft your account. “It’s a payment card that can be funded by check, cash, or simply transferring funds from your bank account and can be used wherever regular Visa, MasterCard, or American Express cards are accepted,” explains Soriano.

With a prepaid card, you could load $1,000 to spend onto it. If you spent $750, there would be $250 left on the card. You could spend that amount -- but no more than that until you loaded more money onto your card.

Despite the similar look and feel of a credit card, managing a prepaid card is more like having a checking account with a debit card than it is having a traditional credit card account. There is less to worry about in terms of interest charges, due dates, or missed payments.

One great way understand the differences in how prepaid, debt, and credit cards all work is by looking at it this way: with a prepaid card, you pay for your purchases before you put them on your card. With a debit card, you pay as soon as you swipe the card at the checkout. And with a credit card, you get to buy now -- but you actually pay later, when your statement is due.

If you struggle to manage your credit or spending, the simplicity of prepaid cards can be a big benefit. And of course, there’s the failsafe that you can only spend what you load onto the card.

No Bank Account? No Problem

If you don’t have a bank account, you’re not alone. Nearly 37 million Americans don’t have one, either. And if you don’t, that means you can’t use a debit card. There’s no checking account to tie your card to. It might be difficult for you to get a credit card with no bank account, too.

But you still need to make purchases and pay your bills. A payment method like a card can help make that a lot easier and safer than constantly carrying cash. You also need a card if you want to do things like make purchases online.

Prepaid cards make managing finances a little easier even without a bank account. These cards provide a reliable way to receive and spend money without using traditional banking channels.

Stellar Credit Not Required, Either

In some cases, people with poor credit turn to prepaid cards because you can get one without having a great credit score. The best unsecured credit cards require the best credit scores -- and even secured credit cards might be hard to qualify for if you’re currently recovering from a big financial mistake.

Kasey Ring is a financial planner who founded Upward Personal Finance, and she says prepaid cards are like training wheels for using credit. You can start building good financial and spending habits without dire consequences if you slip up a time or two.

“It’s a good option to explore for those who have been in trouble with their credit in the past,” she says. “Prepaid cards allow you to reset and get back into the credit game without opening up another opportunity for failure.”

Stay Out of Debt While Still Using Plastic

Prepaid cards come with an easy approval process and don’t require you to have any credit at all. But you can still use them much like you’d use a revolving line of credit, including the ability pay bills and make purchases online.

One of the biggest benefits of using a prepaid card is that it allows you to use a payment method very similar to a credit card, but without the risk of spending more than you can afford to repay. It can help you budget and stick to your spending plan.

Prepaid cards even offer the same fraud protection as traditional credit cards. If your card is lost or stolen, you have some recourse in protecting yourself and your money thanks to new CFPB rules. These new protections for consumers also include an overhaul of the way prepaid card companies offer terms and benefits. They’ll also start more clearly defining the fees of these cards.

The new rules cover a variety of different kinds of prepaid cards, including cards used to receive government benefits, payroll cards, and general purpose prepaid cards. Electronic accounts that allow you to store money in an online portal (think Google Wallet and PayPal) will also offer more consumer protections.

Watch Out for Potential Trouble Spots

While there are plenty of benefits for consumers using these cards, there are a few places where prepaid cards do fall short. One of the biggest issues: the number of fees involved.

You can get hit with activation fees of anywhere from $5 to $10 for each prepaid card, along with additional fees to load money, check balances, withdraw money from an ATM, and even speak with a representative over the phone. And when the card issuer charges a fee, the amount of charge comes out of your balance.

And while prepaid cards make it easy to spend with no bank account, they certainly don’t address your need to save, too. If you’re avoiding getting a bank account due to fees, you might want your money going to an institution who can provide you with both a checking account (that comes with a debit card) and a savings account you can use.

You pay a lot of fees with prepaid cards. Make sure that’s truly the best way to pay for the ability to use your money.

If you use a prepaid card, you also need to watch out for fraud. Prepaid cards are easy to use and exist outside the traditional banking system. There are fewer protections on these cards, and no financial institution to help you monitor the card’s activity.

You may receive phone calls or emails from people posing as legitimate creditors. They could claim that your account is past due and ask you to reload a prepaid card to bring the account current. Providing those details to fraudulent users gives them the withdraw your cash -- and leaves you with very few options for recourse. If you get suspicious calls or emails, don’t respond. Go directly to the card issuer yourself, report the activity, and make sure your account is in good standing.

Will a Prepaid Card Impact Your Credit?

Prepaid cards don’t require a credit check. You can easily get one regardless of your credit history. (Since you’re not borrowing money, there is no reason for the card issuer to check your credit.)

That said, prepaid cards won’t improve or help you establish credit. Loading money on a card and spending it doesn’t provide enough information about your borrowing and repayment habits for card issuers to have anything to report to the credit bureaus. Nothing that you do on a prepaid card will appear on your credit report or be reflected in your credit score.

If your goal is to build or repair your credit, a secured credit card is likely a better option for you. Secured credit cards are very similar to prepaid cards. You need to put down money in the form of an initial deposit before you can use the card. But with a secured credit card, the deposit is held as collateral in the event you fall behind on your card payments.

Try a Prepaid Card to Help You Stay on the Right Financial Path

Prepaid cards give you the opportunity to spend your own money, not the bank’s, and avoid the temptation to overspend. There’s no way to accumulate debt on these cards and you don’t need to worry about interest charges.

If you don’t have a bank account or simply have poor credit, a prepaid card can provide you with a payment option that’s safer than carrying cash. But you need to watch out for fees and fraud. In most cases, getting a bank account if you can and using a debit card makes more financial sense.

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