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What You Should Know About Prepaid Cards

What You Should Know About Prepaid Cards

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This article was last updated Jul 29, 2019. Terms and conditions may have changed. For the most accurate information, please consult the issuer website.

It’s easy to confuse a prepaid card with a credit card if you’re not looking closely. Many prepaid cards are branded with recognizable credit card networks, such as Visa, Mastercard, and American Express. But there are some key differences between prepaid cards and credit cards, and you should understand the pros and cons before deciding what’s best for your wallet.

Let’s look at how prepaid cards work, how they differ from credit cards, and who they’re best for.

In this article:

How do prepaid cards work?

Once you buy a prepaid card (also called a prepaid debit card), you can load it with funds, then use it to make purchases. There are a variety of ways to load funds onto the card, including direct deposit from your paycheck, transferring money from a checking account or another prepaid card, buying a “reload pack” and adding money to the card at certain stores.

When you make a purchase using a prepaid card, the amount of the purchase will be deducted immediately from the funds loaded onto your card. In this respect, prepaid cards are similar to debit cards, which deduct money directly from your checking account when you buy something.

The difference between prepaid cards and debit cards is that prepaid cards aren’t linked to the cardholder’s bank account. If, for some reason, you don’t want or can’t get a bank account, a prepaid card can provide an alternative way to manage your money, receive direct deposits, and pay merchants that don’t accept cash.

Read The Best Prepaid Debit Cards

However, there’s a cost for the convenience. Prepaid cards can come with a variety of fees, two of the most common being a recurring monthly fee and a reloading fee for when you funnel more money onto your card. There are ways to avoid certain fees — for example, some cards won’t charge you a reloading fee for funds loaded on the card by direct deposit — but you should pay attention to these fees and make sure to understand how much they can eat into your available funds. 

Things are much, much better today when it comes to consumer protections for prepaid cardholders than they had been before.

Some prepaid cards offer reward points or cash back. While these are usually nowhere close to the generous rewards you can earn with a credit card, they might help offset any fees the prepaid card charges.

Another area where credit cards are better than prepaid cards is cardholder protection — though prepaid card protections have improved recently, thanks to a new rule by the federal Consumer Finance Protection Bureau.

“Things are much, much better today when it comes to consumer protections for prepaid cardholders than they had been before,” said Matt Schulz, chief industry analyst at CompareCards.com. “It used to be that if your prepaid card was used fraudulently or if you lost the card, you were generally out of luck. Add in inconsistent disclosures, often-rampant fees and other issues, and prepaid cards became a fairly risky proposition.”

“The CFPB’s new rule that took effect earlier this year reduced the risk a great deal,” Schulz added. “It mandated specific disclosures, it guaranteed your right to check your account balance for free and, perhaps most important, it limited your liability if your card was used fraudulently. The one important caveat is that in order for that liability protection to kick in, you have to register your card with the issuer. It’s an extra step, but considering the peace of mind it can bring, it is a step worth taking.”

Registering a prepaid card can also provide protection in the event the card is lost. This is an especially important protection when using a prepaid card, since the card is loaded with cash.

What are the benefits of a prepaid card?

If you don’t have a bank account, a prepaid card can give you a way to manage your money without having to carry around cash, and can allow you to receive your paycheck by direct deposit.  It can also give you a way to shop online and at merchants that don’t accept cash.

Even if you do have a bank account, prepaid cards can also be a good budgeting tool by limiting the amount you can spend to the amount of cash on the card instead of a large credit line. In addition, some prepaid cards offer secondary cards or subaccounts, which you can use if you want to load funds for family members.

Why prepaid cards don’t build your credit score

While prepaid cards can be convenient, they won’t help build your credit score. Conversely, credit card accounts and payments are reported to the three major credit bureaus — Equifax, Experian, and TransUnion.

Here’s how the Consumer Financial Protection Bureau, a federal government agency that works to protect and inform consumers, explains the situation on the agency’s website:

“With very few exceptions, most prepaid card providers that claim to offer a way to build your credit history only report your activities to a lesser-used credit reporting agency, not one of the three major credit reporting agencies used by most lenders.”

So if you’re looking at a prepaid card as a way to help control your spending by limiting your access to just the funds loaded on the card versus a large credit line of a credit card, it might be what you need. But if you want to build credit or improve your credit score, consider other options — such as a secured card or a card aimed at customers without an existing credit history.

Alternatives to prepaid cards

If you’re looking for a tool to keep spending under control or to use in place of cash, a prepaid card may be just the ticket. But if you need something that can help build your credit score, or if you want to earn generous rewards, a credit card might be a better option. Here is a secured card to consider:

Discover it® Secured

  • 2% cash back at Gas Stations and Restaurants on up to $1,000 in combined purchases each quarter. 1% unlimited cash back on all other purchases - automatically

  • Credit line will equal your security deposit of $200 or more*

  • No annual fee, no late fee on your first late payment. No penalty APR*

Highlights
  • No Annual Fee, earn cash back, and build your credit with responsible use.
  • It's a real credit card. You can build a credit history with the three major credit bureaus. Generally, debit and prepaid cards can't help you build a credit history.
  • Establish your credit line by providing a refundable security deposit of at least $200 after being approved. Bank information must be provided when submitting your deposit.
  • Automatic reviews starting at 8 months to see if we can transition you to an unsecured line of credit and return your deposit.
  • Earn 2% cash back at Gas Stations and Restaurants on up to $1,000 in combined purchases each quarter. Plus, earn unlimited 1% cash back on all other purchases – automatically.
  • Get 100% U.S. based customer service & get your free Credit Scorecard with your FICO® Credit Score
  • INTRO OFFER: Unlimited Cashback Match – only from Discover. Discover will automatically match all the cash back you’ve earned at the end of your first year! There’s no minimum spending or maximum rewards. Just a dollar-for-dollar match.
  • Get an alert if we find your Social Security number on any of thousands of Dark Web sites.* Activate for free.
  • See Rates & Fees

See additional details for Discover it® Secured

More Info

The Discover it® Secured is a secured credit card, meaning you have to make a security deposit in order to open the card. Your deposit won’t count toward your payments — you’ll still have to make payments on anything you charge to the card.

What makes this card unique among secured cards is that it offers rewards — you can earn 2% cash back at Gas Stations and Restaurants on up to $1,000 in combined purchases each quarter. 1% unlimited cash back on all other purchases - automatically The annual fee is $0 and the APR is 22.99% Variable.

After you’ve had this card for eight months, Discover will begin monthly reviews of your account to see if you’re eligible to transition to an unsecured card and get your deposit refunded.

Read The Best Credit Cards for Bad Credit

The bottom line

It’s often better to make purchases with a credit card than a prepaid card, both for cardholder protection and for the opportunity to earn rewards. But if you’re looking for something with more flexibility than cash — or if you need a budgeting tool that can limit your spending or that of family members — prepaid cards can offer a middle ground between cash and credit cards.

“A prepaid card can make sense for someone who doesn’t have a bank account, as long as they understand what they’re getting into,” Schulz said. “For example, it’s important to know that these cards can come with a lot of fees that you might not see with a typical bank account. A prepaid card does not make sense if you’re trying to kickstart or rebuild your credit.”


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