Reader Question: Can You Build Credit with a Prepaid Card?

Last week we published a list of free and low cost prepaid cards. In response, a reader asked about building credit with a prepaid credit card:

Is using a PrePaid Credit Card a way to build a credit history for someone who doesn’t have one?

This is a great question, and underscores how confusing the different types of credit and debit cards can be. The short answer is that some prepaid cards can build your credit history, but most do not. We'll take a look at some of the prepaid cards that can help you build credit. But first, let's sort through all the different types of credit, debit and prepaid cards, and how each generally can affect your credit score and credit history.

Credit Cards: Credit cards like Discover, Chase, or Citi represent a loan each time you use your card. Because you are borrowing money, your account is reported to the major credit bureaus. As a result, using a credit card will impact your credit score.

Debit Cards: Debit cards are issued by banks and generally are tied to a checking account. While debit cards today look like credit cards, including the Visa or MasterCard brand, they are more akin to writing a check. When you use a debit card, the cost of the transaction is taken out of your checking account. As a result, debit cards do not help you build credit.

Prepaid Cards: Prepaid cards are very similar to debit cards, except that they are not linked to a bank checking account. Instead, you transfer money to the card (via direct deposit, online, at certain stores, etc.) and then can use the card anywhere that accepts Visa or MasterCard. While these cards are sometimes referred to as prepaid credit cards or prepaid debit cards, they are really just prepaid cards. Because you can only spend the money you have already added to the card, prepaid cards do not represent a loan like a credit card. As a result, prepaid cards generally do not help you build your credit.

There are, however, some exceptions.

Prepaid Cards that Help You Build Credit

Some prepaid cards have added features to the account that will enable a cardholder to build a credit history. The approach that each card takes is different, and understanding the differences and costs involved is important.

AccountNow Prepaid Visa or MasterCard

AccountNow enables cardholders to build a credit history in two different ways. The first is called Credit Builder, and there is no cost associated with this option. By activating AccountNow's bill pay feature, you can pay monthly bills (e.g., rent and utilities) online. AccountNow will report these monthly payments to PRBC, a national credit reporting agency. PRBC is not one of the three major credit reporting agencies, but according to AccountNow, home loan associations like Freddie Mac and Fannie Mae and Citicorp Mortgage use bill payment information as part of their decision making process for home loans.

The second way to build credit with AccountNow is by using their iAdvance line of credit feature. iAdvance requires that direct deposit be set up on the account. It then enables account holders to take loans on the card from AccountNow, which are then repaid automatically when the next direct deposit is added to the card. AccountNow reports these payments to the major credit bureaus. Like most short-term loans, an iAdvance loan is expensive, the cost depending on the amount of the advance.

You can get more information about the AccountNow Prepaid cards at www.accountnow.com.

Eufora Prepaid Card

Eufora takes a very different approach to building credit. Eufora offers a Credit Builder program that runs for two years at a cost ranging from $6.95 to $10 per month, depending on the type of Eufora account you open. Eufora then reports these monthly payments to two of the major credit bureaus, TransUnion and Experian. Note that the Eufora Credit Builder program requires a two year commitment.

Update: I've just learned that the Eufora card is no longer available.

Are Prepaid Cards a Good Way to Build Credit

While you can build credit with a prepaid card, the question remains whether it is the best way to build credit. Low cost prepaid cards are a safe, convenient way to manage money for those that want to avoid credit and are unable to qualify for a checking account (usually because of Chexsystems). For those that have no other way to build credit, these prepaid cards are a reasonable alternative. Because the Credit Builder feature does cost money, however, you should consider no cost alternatives first.

For example, you may be able to qualify for a store credit card (e.g., Sears or Home Depot). By making a few purchases each month for items you'd buy anyway and paying off the balance in full each month, you'd build your credit at no cost. Of course, the risk with credit is that you'll spend more than you should and find yourself in debt at double-digit interest rates. But if you can manage the credit well, you can build a credit history and improve your credit score at no cost.

If you've used a prepaid card to build credit, please leave a comment and let us know how it worked out for you.