How is a prepaid card different from a debit or credit card? Get the facts here.
If you’re a student or just starting out on the road to adulting, a prepaid card might be a good option. Prepaid cards are a convenient alternative to cash and make it possible to use plastic even if you don’t have an established credit history. In this article, we’ll look at what prepaid cards are, how they work, and if they’re right for you.
Prepaid Cards and How They’re Used
Like a credit card or debit card, a prepaid card can be used to pay for purchases instead of cash. Unlike debit cards, prepaid cards aren’t linked to a bank account. With a prepaid card, money is loaded onto the card and that balance works as your spending limit. You can buy prepaid cards at stores and online. They are also used by some employers as a form of payment. Prepaid cards offer convenience and have a variety of uses. These include:
- Making in-store and online purchases
- Paying bills
- Receiving direct deposits or payments from an employer
- Storing and transferring funds
Different Types of Prepaid Cards
Prepaid cards come in several different types and not all of them work the same way. Let’s look at each type of card so you can choose the one that’s best for you.
- Gift cards: There are two types of gift cards. “Closed loop” gift cards are available from a particular retailer (like grocery stores, coffee shops, restaurants, gas stations, and online businesses) or specific agencies (like a public transportation system) for use only at locations indicated on the card. “Open loop” gift cards have a network brand, like Mastercard or Visa, and can be used anywhere debit and credit cards are accepted.
- General purpose reloadable cards (GPRs): Also called stored-value cards or pay-as-you-go cards, these are “open loop” cards issued by payment networks like Visa or MasterCard for a set amount and is reloadable. And, like a credit card, they can be used wherever that payment network is accepted. You can purchase GPR at retail stores, but you can also buy them from financial institutions or credit card companies.
- Payroll cards: Some employers use prepaid cards to pay their employees, especially if an employee doesn’t have access to a checking or savings account.
- Government benefit cards: Some government agencies use these cards to issue benefits such as unemployment, food stamps, Social Security, and veterans’ assistance.
The Difference Between Prepaid Cards and Debit and Credit Cards
Prepaid cards may look the same as credit and debit cards, but they have two main differences: how you get them and where the money comes from.
How you get them:
- Prepaid cards: You purchase them yourself or they are given to you.
- Credit and debit cards: You must apply for an account with a credit card company or financial institution.
Where the money comes from:
- Prepaid cards: Money is preloaded onto the card by the person who purchases it or issues it. Spending is limited to the balance on the card.
- Credit card: When you use a credit card to pay for something, you borrowmoney from a financial institution, which must be paid back at the end of the month. If you don’t pay the entire balance on your credit card, interest is added to the amount you owe.
- Debit card: The money comes from your checking or savings account. If you spend more than you have in the account, you will be overdrawn and may be charged fees.
Benefits of Using a Prepaid Card
Let’s look at the pros of using a prepaid card:
- Lower risk: Because you’re generally only using money that’s already on the card, there’s no risk of racking up debt or negatively impacting your credit.
- Can’t overspend: Prepaid cards have built-in spending limits.
- Builds financial skills: Many people use prepaid cards to develop financial skills and control spending. Think of them like a practice debit or credit card – but without the risks.
- No bills: With a prepaid card, you use only what’s on the card (or what you reload), so you are not charged interest or do not receive a bill each month – and therefore have no missed payments.
- Easy to get: You don’t need to have a credit history or a checking or savings account to get a prepaid card.
Drawbacks of Using a Prepaid Card
While a prepaid card may be easier to get than a debit or credit card, there are some disadvantages:
- Won’t help you build credit: Unlike having a credit card, most prepaid cards won’t have any effect on your credit report or credit score. You build credit by applying for credit cards or loans and showing that you can use that credit responsibly. That’s not something you can show if you use a prepaid card.
- High fees: While you won’t pay interest charges with a prepaid card, that doesn’t mean they cost less to use. There can be various fees associated with prepaid cards, including activation, cash reload, transaction, transfer, or card replacement fees.
- Limited services: With a prepaid card, you may not automatically get the services you’d expect from a checking account. These include free access to an ATM network, online or mobile banking, wire transfers, and the ability to stop payments.
- Security: Prepaid cards are protected by the Electronic Fund Transfer Act, which is weaker than the laws protecting credit cards.
Prepaid cards come with a certain amount of protection guaranteed by the Consumer Financial Protection Bureau (CFPB).
- Fraud, unauthorized charges, and errors: You have the right to dispute unauthorized charges or charges made in error. To do this, you will generally need to register your card with the issuer and verify your identity. The company will investigate the dispute and reimburse you if they detect fraud or error if you report it in a timely manner.
- Fee transparency: As a consumer, you are entitled to review all fees before purchasing a prepaid card. A list of fees must be available on the outside packaging of the cards, on the company website, and with the CFPB.
- FDIC and NCUA Insurance: To protect you if the card issuer goes out of business and takes your money with them, most prepaid cards are FDIC (Federal Deposit Insurance Corporation) insured (for credit unions, it’s NCUA, or National Credit Union Administration, insurance). If a prepaid card is not FDIC or NCUA insured, that must be stated on the packaging.
- Lost or stolen card: If your card is lost or stolen, report it immediately! Don’t delay, as some card issuers may refuse to investigate reports if too much time has passed. If you report a lost or stolen card within two days, you will be liable for only $50 of unauthorized transactions. If the two-day deadline slips by but you report within 60 days, you may be liable for up to $500 of unauthorized transactions.
Prepaid cards aren’t for everyone. If you want to build or rebuild credit, there are other options available.
- Secured credit card: These credit cards that require a cash deposit as collateral. The amount of your deposit is usually the same as your credit limit. For example, a $300 deposit gives you a $300 credit limit. Your deposit protects the credit card issuer if you don’t pay what you charged – they can subtract that amount from your deposit. A big advantage of a secured card, especially if it’s your first credit card, is that the card issuer reports your credit information to all three credit bureaus. By making purchases with the card and paying them off on time, you can build a positive credit history. Just be aware that, like most credit cards, you may need to pay annual or processing fees.
- Applying for an unsecured credit card: Even if your credit score isn’t the greatest, you can probably find a card that doesn’t require an upfront deposit. You’ll want to do your research and apply only for a card that best meets your needs. Every time you apply for a credit card, a hard inquiry appears on your credit report, which can temporarily ding your credit score. For that reason, it’s best to keep hard inquiries to a minimum.