There are so many choices when it comes to credit cards – different banks, logos, perks, fees, etc. How do you know which card is right for you?
When most people think about credit cards, they think of a “traditional” credit card. These cards, typically issued by banks, credit unions and retailers allow a buyer (you) to take possession of something now and pay for it later (either in full or over a period of time). You are sent a monthly bill for all the charges incurred during the billing cycle. If you are unable to pay your balance in full, you are charged interest or a fee on the amount you did not pay back. When buying something “on credit”, creditors (organizations you owe money to), report your history of making payments (on-time or late) to three credit reporting agencies, Equifax, Experian and TransUnion.
If you are unable to obtain a traditional credit card (i.e. you have been denied) or simply choose not to get a traditional card, there are other “credit” options available to you – a prepaid credit card or a secured credit card. But what is the difference between the two?
Prepaid credit cards require you to deposit a dollar amount (in any amount you choose) on the card. The funds are then drawn down as you make purchases (similar to a gift card). Many prepaid credit cards are “reloadable,” which means you can add funds to replenish your credit line at any time for continued use. Prepaid credit cards are typically issued by major creditors (Visa, Mastercard, Amex, etc.) and can be used anywhere their card is accepted.
Comparatively, a secured credit card, also issued by major creditors, requires you to provide the creditor with collateral (typically money). In turn, you receive a credit card with a credit limit valued at the amount of the collateral (or another agreed upon amount). A secured credit card is used just like a traditional credit card where you make purchases throughout the month (up to your credit limit). When you make purchases, funds are NOT withdrawn from your collateral. Instead, at the end of the billing cycle you receive a bill for the purchases made. You elect to pay your balance in full (which is recommended) or a lesser agreed upon amount, referred to as the minimum payment, in order to keep the account in good standing. If you do keep your account in good standing, when you close the credit card or after a period of on-time payments, the collateral will be returned to you. If you do not keep your account in good standing, the creditor will use the collateral as payment.
Now that you know more about how each credit card works, what are the advantages and disadvantages of each card?
Prepaid Credit Card
– Helps you control your spending because you can only spend up to the amount deposited on your prepaid credit card
– Allows you to purchase items that cannot be bought with cash (i.e. online transactions) or at companies that require a credit card to utilize their services (i.e. car rental).
– Fees are typically charged on activities such as card activation, monthly maintenance, cash withdrawals, balance inquiries, paper statements, account inactivity, and much more. Fees may appear nominal, but they add up quickly. Shop around for the card that is right for you
– Account activity is not reported to the credit reporting agencies. Therefore, a prepaid credit card does not help you establish or re-establish your credit history
Secured Credit Card
– Most secured credit cards report your account activity to the credit reporting agencies. If the card is used responsibly (i.e. on-time payments), it will help you establish or re-establish a positive credit history
– If your credit report shows you have used your secured credit card responsibly, when you apply for a loan or a traditional credit card, you are more likely to be approved with favorable terms (low interest rate)
– Fees typically include an annual fee, monthly fee and interest is charged on any balance you do not pay at the end of the billing cycle. Interest rates vary, so shop around for the best rate
– Just like traditional credit cards, late payments are reported to the credit reporting agencies, adversely affecting your credit history
All credit cards have their pros and cons. Before you decide if a prepaid or secured credit card is right for you, consider all of the advantages and disadvantages each card has to offer and how the card will help you reach your financial goals. If you have any additional questions about the difference between prepaid credit cards and secured credit cards or need help deciding which card is right for you, contact one of our Certified Personal Finance Counselors at 888.354.6332. We can help you on your way to …a brighter tomorrow.