If you have no credit history, or if you have a poor credit score due to past credit problems, you may have heard about secured credit cards. On the surface you might have thought, “What’s the point? It sounds like another name for a prepaid debit card.”
There is actually a very big difference between secured credit cards and prepaid cards.
Let’s start with prepaid credit cards. These are fairly straightforward. You put money into an account (or maybe have a debit card linked to your bank account) and you use the card like any other credit card. When you make a purchase, the money immediately comes out of the card’s balance. In this way, prepaid cards are almost like cash. Gift cards also work in this same way. Easy to understand; you’ve probably dealt with plenty of gift cards or debit cards in the past.
Secured credit cards are a totally different animal. The only similarity comes upfront. In order to get a secured credit card, you deposit money into a bank account, similar to how a prepaid card works. BUT, when you make purchases with the card, the money does NOT come out of your deposit. Instead, the secured credit card works like any other credit card — you make your purchases and get billed each month. Your payment does NOT come out of the money you deposited —you must pay your bill out of other money.
Now, why would you put money into an account to get a credit card that you can’t pay off with the money you put into the account?
This is where the “secured” comes from in the name “secured credit card.” The money you deposit is like collateral on a loan; you’re giving that money as part of a promise to pay on your credit card each month. The only time that deposit would be touched is if you fail to pay your balance. In this way, it is also like the security deposit on an apartment — it is there in case you don’t pay. If you pay like you are supposed to, eventually you can get your deposit back when you no longer want the card (and when the card is paid off, of course). Again, you can compare this to a landlord giving back the deposit when you move out (assuming you’ve paid all your rent).
OK, if you’ve come this far, you might still be wondering: “Why would I want a secured credit card when I could just use a prepaid card? After all, I could just put money on a prepaid card and actually use that money instead of having it just sit there like a security deposit.”
The answer is this: a secured credit card can help you build a good credit record. (A prepaid card can’t.)
Banks that offer secured credit cards report your payment history to the credit bureaus (Experian, TransUnion, Equifax). This is how a new (or improved) credit score gets built. Every time you make your secured credit card payment on time, your score improves just a little. Over time, it will hopefully improve enough that you will not need a secured card anymore, and you can get a standard, unsecured card. In fact, several banks that offer secured cards will tell you that your account will be reviewed periodically to see if your score has improved enough to get a better card. (If it does, you’ll get your initial secured card deposit returned to you, assuming your bills are paid in full.)
So, that is the case for secured credit cards vs. prepaid cards — if you are interested in exploring further, we offer a list of secured credit cards that offer reasonable terms.