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How Prepaid Credit Cards Work: The Basics

how prepaid credit cards work woman makes purchase

Are you looking for an alternative to traditional credit and debit cards? There are many reasons why you might consider using a prepaid credit card instead. Maybe you want to stay away from traditional banks or control your spending and avoid overdraft fees. Or maybe you simply want to make travel more secure or give you kids some spending money. If so, you might be wondering how prepaid credit cards work and if they would be a good fit for your situation.

These cards are an alternative to traditional credit cards and debit cards tied to banks or other financial institutions. Prepaid cards can be used anytime you don’t want to pay in cash. The money is loaded onto the card ahead of time—or “prepaid”—and you use it while shopping to pay for your purchases.

Many people choose prepaid credit cards because they are easy and inexpensive to get and don’t require a credit check. They do have some disadvantages as well, so before committing to one, you should learn how prepaid credit cards work.

How Does a Prepaid Credit Card Work?

Despite its name, a prepaid credit card is not actually a credit card. While not tied to a line of credit, these cards are known as “credit cards” because they work and are used somewhat like credit cards, and are made and sold by major credit card companies. You can buy one from a bank, directly from the credit card company, and even at stores.

You decide how much money to put on the prepaid credit card. Some come preloaded with money, some are made for one-time use, and others are reloadable so you can keep adding money and reusing them.

Prepaid credit cards actually work very similarly to a bank debit card, except they are not tied to a bank account. Each purchase will reduce the balance on your card, but unlike debit cards, it is impossible to overspend the balance. You can transfer funds to your card through your bank or direct deposit or sometimes by bringing cash to a retail store that can reload it for you.

Is It Worth Getting a Prepaid Credit Card?

What are the benefits of prepaid cards, and what are the disadvantages of prepaid cards? These cards work well for some people, but it is good to be aware of the pros and cons.

Benefits of prepaid cards:

  • No credit history is required, so anyone can get one. If you have no credit or poor credit, you don’t need to qualify for a prepaid credit card.
  • You don’t need a bank account to use a prepaid credit card and may choose to use one as an alternative to using a bank-linked debit card.
  • They make great gifts for teens and college students.
  • Prepaid cards can help you with budgeting—for example, you can preload your budgeted money for gas or groceries at the beginning of the month and stop spending when you run out.
  • You can load cash whenever you want.
  • They’re great for travel, especially if you’re worried about privacy and fraud issues.

Disadvantages of prepaid cards:

  • Prepaid cards do not help your credit score. Because they aren’t tied to any credit, they can’t help you build credit if you don’t have any or improve your credit if it is poor. But, on the other hand, how you use them can’t hurt your score either.
  • Fewer consumer protections on prepaid cards mean you might be in trouble if someone steals your card or card number and uses it to make purchases or if the card issuer goes out of business.
  • These cards aren’t free—there are often fees, and some of them can be hard to identify. You may have an activation fee, a fee per use, a fee to withdraw funds from an ATM, or an inactivity fee.
  • You don’t earn interest with a prepaid card, as you would with a traditional savings and checking account.

How Can I Use a Prepaid Credit Card?

Generally, a prepaid credit card can be used in place of cash, credit cards, and debit cards both online and in person. The most notable exception is renting a car. Most major American car rental companies won’t accept payment through prepaid credit cards. When you rent a car, your best bet is to use a bank-issued credit card. If you find a company that will accept a prepaid credit card from a major company, remember that most prepaid cards don’t offer insurance, so you’ll need to purchase insurance from the car rental company.

Online purchases, including hotel booking and paying bills, are possible with a prepaid credit card. You can pay for recurring subscriptions and other payments if the card is registered in your name. That’s one of the biggest problems you’ll run into online—most online payment forms won’t accept a card without a cardholder name. If you plan to use your prepaid credit card online, choose a card that can be registered to your name.

Given this information, are prepaid cards a bad idea? It depends on your situation and why you might want to use them. If you are trying to avoid banks and can handle the fees, or if you need a cashless way to pay but have poor credit, they are a good option. If you want to build credit and avoid fees, it’s better to look into alternatives.