What Are The Pros And Cons Of Prepaid Credit Cards?

What Are The Pros And Cons Of Prepaid Credit Cards?

Written by Bryan Daly
Fact-checked by Caitlin Wood
Last Updated March 23, 2023

There is seemingly no end to the various credit products available to us. However, easy access to personal loans, credit cards, and the like is not always great. Especially when our spending habits can easily get out of control. Enter the prepaid credit card. A tool used by many consumers to help curb spending and stick to a budget. So, how do prepaid credit cards work and are they the right option for you?

What Is A Prepaid Credit Card?

Before weighing the benefits and drawbacks of using prepaid credit cards. We must first learn what they are. Unlike a traditional credit card, which will have a monthly credit limit, a prepaid credit card has a total cash limit. Instead of that limit resetting itself once you pay off the balance. A prepaid credit card already has a specific amount of money on it.

How Do Prepaid Credit Cards Work?

If you should spend any money held on your prepaid credit card, the limit will drop in accordance with how much you’ve spent. The limit that a prepaid card can hold is typically dependent on the policies of the company that issues it, but it can range anywhere from a few hundred dollars, all the way up to $15,000 in some cases.

Prepaid cards are usually purchased through the same companies that deal in normal credit cards, such as Mastercard or Visa. Although in recent years, the prepaid credit card has gotten a bit of a makeover. With companies like Neo and KOHO that promote their cards to help users track spending and stay on budget.

How To Use A Prepaid Credit Card

Anyone who wants a prepaid credit card needs only choose the best option for their needs and open an account with the company.

Where prepaid cards differ from regular credit cards is that they usually require no credit check or application. You simply need to be 18 years of age or older. Parents will often open a prepaid account for their children as a gift, or to introduce them to the idea of using credit, all while keeping their spending under control.

A prepaid card functions much like a gift card that you would purchase from any retailer, but that you can use in multiple types of locations. Cards resemble a typical chequing account, more than they do an actual credit card. If you decide to put $500 on the card, then buy something that costs $200, you’ll have $300 remaining until you decide to fill the card up again. Like a regular credit card, you can pay for things using an electronic terminal at retailers, restaurants, gas stations, or anywhere else prepaid cards are accepted. You can also use it for purchasing things online and over the phone.     

Prepaid Credit Cards vs. Regular Credit Cards

While at first glance, prepaid cards might look exactly the same as traditional credit cards. The way they function is altogether different.  

Spending Your Own Money

When you use a prepaid credit card, you’re spending the money you have. With a regular credit card, you’re borrowing money from your bank or other financial institution.

No Monthly Payment

Prepaid credit cards require no monthly payments. With your regular credit card, you’ll have a balance to pay each month. If you fail to pay your balance, you could be charged a penalty. However, there will be a minimum payment that you can make to avoid penalties. Once you’ve paid your full balance, your credit limit resets. The only limit a prepaid card has is how much money you’ve put on it.

No Interest  

There is no interest charge associated with a prepaid credit card. Unlike, a traditional credit card where you’ll be charged interest on any balance you do not pay off by the due date.

Does Not Affect Credit Scores

Any activity on your regular credit cards may appear on your credit report and affect your credit scores in various ways. Responsible usage (paying your bills on time and in full, not going over your credit limit, etc.) may have a positive effect on your credit. While any irresponsible usage (late payments, etc.) may have a negative effect on your credit. Prepaid cards have no effect on your overall credit health.

Secured Credit Cards vs. Prepaid Credit Cards

Both secured credit and prepaid cards are often advertised to those with poor credit. Both types of cards also require you to put money on them upfront. With a prepaid card, you must put money on it before you can use it. Secured credit cards require a deposit before they’re activated.  

Then again, secured credit cards are also different in certain ways.

You Are Borrowing Money

While prepaid credit cards and secured credit cards may both be good options for those with poor credit. It’s important to understand that a secured credit card is a true credit card.

You’ll have a specific revolving credit limit that goes up and down as you make purchases and pay your bill. You’ll also need to keep up with monthly payments, be charged interest, and incur penalty fees if and when you miss payments. None of this applies to prepaid cards.

Security Deposit Required

Yes, secured cards are called “secured” because they require a security deposit. However, that deposit will be put in a separate savings account or a certificate of deposit. So, if the consumer should default on their payments, their deposit is forfeited. If they keep up a streak of responsible credit usage, they may be able to switch over to an unsecured credit card, and their security deposit will be refunded. When you use a prepaid card, the money you’ve put on it, your money is gone.  

Can Help Build A Healthy Credit History

Responsible and irresponsible use will also have an effect on your overall credit. Prepaid cards, no matter how you use them, do not affect your credit.

May Have An Annual Fee

Some secured cards, like regular credit cards, have annual fees. Prepaid cards do have fees, but for different reasons (read the sections below for more information).

You’ll be offered the same services as a regular credit card, such as balance protection in the event of unemployment, disability, etc. Since a prepaid card already contains your money, there’s no need to offer this.

The Advantages Of Prepaid Credit Cards

Prepaid credit cards come with many qualities that make them attractive to some consumers. For example:

  • You don’t need good credit or any credit history. And no credit check is required.
  • No need to apply for a prepaid card, as you would with a typical credit card.
  • Track your spending and stick to a budget easily.
  • You won’t have to deal with late penalties, interest charges, or monthly bills.

The Disadvantages of Prepaid Credit Cards

While they have many noteworthy qualities, prepaid credit cards, like any type of financial product, do come with their disadvantages, such as:

  • Certain locations do not accept prepaid cards.
  • Some prepaid cards cannot be used outside the country where they were activated.
  • If you spend everything on the card, you won’t be able to use it again until you refill it. No revolving credit might mean no money during an emergency.
  • Prepaid cards will not rebuild or affect your credit in any way. Since the card is based on money, rather than credit, the card company will not report any activity to Canada’s credit reporting agencies (Equifax and TransUnion).

What Type of Consumer Should Use A Prepaid Credit Card?

As we mentioned earlier, there are a few kinds of consumers that can benefit more from the use of a prepaid credit card than they would a regular or secured credit card. Since they aren’t really considered credit cards (just debit-style cards issued by credit card companies) consumers with poor credit are one of the key groups that they’re advertised towards. So, if you happen to have a low credit score and are having trouble getting approved for a normal credit card, prepaid cards might be the right choice for you.

Prepaid cards can also be a good gift for a family member or loved one. The receiver can spend the money on whatever they want and any extra fees will be taken out of the card’s holdings. Once the card is empty, they can simply have it deactivated, then throw it away, or refill it themselves. They are also common among students, who need to pay for books and other supplies, all while sticking to a set limit.

However, if you’re looking to build or improve your credit, a prepaid credit card is not the best choice. In this case, if you already have favorable credit, a regular credit card will benefit you more. If you have poor credit, using a secured credit card until you can have it converted to an unsecured one will likely be the best option.

Always Do Research, then Read the Fine Print!

If you’re thinking about buying a prepaid card instead of a typical credit card, just make sure you’re being cautious about it and taking all factors into consideration beforehand. Do some research before making any decisions, this will help you make sure that both the card company and the card itself are legitimate.

If and when you’ve found a prepaid credit card that you think is a good fit for your financial situation, make sure you know everything about the product that you’re about to buy. Tedious as it may be, just like you should with any financial product, carefully read the fine print in the cardholder clause, this way you’ll be completely informed about any fees and rules that come with the card. If you’re happy with the prepaid card, you can continue to spend wisely until you’re ready for the responsibility of a regular credit card.  

Rating of 5/5 based on 20 votes.

Bryan is a graduate of Dawson College and Concordia University. He has been writing for Loans Canada for five years, covering all things related to personal finance, and aims to pursue the craft of professional writing for many years to come. In his spare time, he maintains a passion for editing, writing screenplays, staying fit, and travelling the world in search of the coolest sights our planet has to offer.

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