A number of financial experts advise consumers who want to build good credit to secure a credit card. However, after the recent recession many individuals turned away from credit cards in an effort to cut down on their balances.
With a fear of accruing more debt, which if handled irresponsibly could result in damage to their credit reports and scores, some consumers showed interest in prepaid cards. According to Javelin Strategy and Research's 2010 Online Retail Payments Update and Forecast, credit card payments accounted for a smaller portion of online transactions in 2010 than they did in 2009, a result of more consumers using prepaid cards and bank-issued debit cards.
Although prepaid cards may help prevent you from taking on larger amounts of debt and interest charges, it's important to note that these financial tools do not afford you the same credit-building benefits of credit cards. Learning the ins and outs of prepaid cards may help you decide whether these options are right for your finances.
Using a Prepaid Card
Loading funds onto a prepaid card requires the cardholder to issue an online transfer, set up a direct deposit or conduct an in-store deposit at select locations. Similar to a bank-issued debit card, money is automatically deducted from a prepaid account's balance after each purchase. When the account is depleted, you must then reload the card before you can use it again. These cards typically carry a number of fees, such as those for activation, minimum balances and annual enrollment.
Why Doesn't Responsible Prepaid Card Use Help Build a Good Credit Score?
The functionality of a prepaid card relies solely on funds the cardholder deposits into his or her account rather than on credit. Thus, prepaid card users make purchases using money they already own, unlike with a credit card, which provides a person with borrowed funds.
As a credit cardholder, you must pay off your balances at the end of each billing period; otherwise, you may face high interest rates and potential damage to your good credit score. It is this act of paying back borrowed funds that leads to changes in your credit reports and scores.
That's a good reason to keep your credit score in mind before you choose to replace your credit cards with prepaid cards.
Source: Prepaid Cards: Building Opportunity around Economic and Regulatory Uncertainty — Javelin: How FIs Can Leverage Recent Economic and Regulatory Changes to Promote Prepaid Cards