I’ve had several readers ask me recently whether they can establish credit with a prepaid credit card. Most recently, a reader named Lynn asked the following:
Please contact me about the availability of a pre-paid credit card to help me establish credit.
The topic of building credit can be a confusing one, and whether prepaid cards can help you establish credit is a particularly thorny issue. So let me summarize the answer, and then we’ll look at the details.
- Prepaid credit cards are NOT credit cards: Unlike a traditional credit card where you buy on credit and pay later, prepaid cards require you to deposit money onto the card first. And you can only spend up to the available balance on the card.
- Some prepaid cards can help build credit: There are some prepaid cards that allow you to pay monthly bills (rent and utilities, for example) with the card and these payments do get reported to a credit bureau. But . . .
- Not the 3 Major Credit Bureaus: Payments with a prepaid card, however, do not get reported to the three major credit bureaus (Experian, Trans Union, and Equifax). Instead, they are reported to a consumer credit reporting agency called the PRBC (Payment Reporting Builds Credit).
- Can’t build your FICO score: Because payments with a prepaid card do not get reported to the three major credit bureaus, they cannot help you build a credit history with them or establish a FICO credit score.
- FICO is king: While building a credit history with the PRBC certainly won’t hurt, it likely will be of little value when you apply for a credit card or loan.
- Alternatives: So if you want to establish a FICO score, your best bet is either a secured credit card or a credit card that caters to people with no credit history.
Prepaid Cards that Report to a Credit Agency
The prepaid credit cards that promote a credit builder feature all work the same way. These cards will report to a credit agency recurring monthly payments you make with the card, such as rent, utilities, cable, and your cell phone bill. And the credit agency they report to is the same–PRBC.
The PRBC is a legitimate consumer credit reporting agency. The PRBC is a Fair Credit Reporting Act compliant national data repository. But the PRBC is different than the major credit bureaus in two significant respects. First, you can actually enroll with PRBC on your own and report your own payment history (other than debt payments) to the PRBC. Second, PRBC builds a credit file not on debt repayment, but on alternative data, such as monthly payments on bills like rent, cable, telephone, insurance and utilities.
And some potential creditors will pull reports from the PRBC. Most notably, PRBC meets the standards for documenting creditworthiness (in the absence of a traditional credit history) for Fannie Mae, Freddie Mac, and FHA. However, for most creditors such as banks and credit card companies, PRBC won’t help you get access to credit.
So What’s the Point of a Prepaid Card?
Prepaid cards can be a low cost alternative to banks and credit cards. They can be used just about anywhere that accepts Visa or MasterCard. Some prepaid cards, like the Walmart Moneycard, come with cash back rewards. And the best prepaid credit cards today are free with little or no monthly fees depending on how the card is used.
However, if your goal is to build your credit, prepaid cards are not the best option.
For people trying to build credit, a secured credit card is a much better alternatives. And the interesting thing is that there is really little difference between a secured card and a prepaid card.
With both cards, you must make a deposit with the card company first. With a prepaid card, your deposit is used to fund transactions you make, much like a bank debit card. Once you spend the money on the card, you have to reload the card with more money before using it again.
With a secured card, however, the money you spend is not deducted from your deposit. Instead, it is treated as credit, and you receive a monthly bill just like a traditional credit card. So rather than replenishing your deposit when you need to spend more money, you simply pay your bill each month.
So what’s the point of the deposit? Good question. It acts as security for the credit card company in the event you don’t pay your bill. For this reason, your credit limit on a secured card will almost always be equal to the amount of your security deposit.
While there is not much practical difference between a prepaid and secured card, there is a huge different when it comes to your credit. Because a secured card is an extension of credit, your payments each month are reported to the three major credit bureaus. And that in turn helps establish credit and your official FICO credit score.
Finally, you can try to apply for a traditional credit card that doesn’t require a security deposit. These can be tough to get if you have no credit, but as noted above, Orchard bank is a good option to try.
Photo credit: SMJJP