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Do Prepaid Cards Build Credit Scores

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“Prepaid Cards don’t hurt your credit – But they don’t help it either”

Let’s get this out of the way first — Do Prepaid cards build credit? Absolutely Not. No matter what you’ve heard, prepaid cards do not help build credit history.

But surprisingly many people, particularly college students, believe prepaid cards build credit. A recent study by U.S. Bank surveyed 1,640 undergraduates between the ages of 18 and 30 about basic personal finance concepts. The survey found that 60% of students said using checks and debit cards helps build credit.

The reason prepaid cards do not help build credit is that customers are using their own funds and no line of credit is extended by the bank or card issuer. You have to use credit in order to build it. That means you need a loan, line of credit, credit card or an account reported to the credit bureaus. With prepaid cards no payment information needs to be reported to the credit bureaus.

Nevertheless, prepaid cards continue to gain in popularity. According to a report from Javelin Strategy & Research more than one in six consumers now carry reloadable prepaid debit cards.

Prepaid cards are typically popular among underbanked, unbanked and young consumers (those who are not actively engaged in the use of traditional banking products). The growth can in part be attributed to rewards programs and advanced online and mobile management tools. Banks and prepaid card issuers have gotten very innovative in their product offerings.

Prepaid cards do not report to credit bureaus

While there is a credit building component in prepaid cards, they do not help with building credit history or scores. Prepaid cards can help you establish a history with a financial institution which may be transformed into a profitable banking relationship in the future. Prepaid cardholders may qualify for additional banking products such as checking accounts, credit cards, and loans.

A credit card for consumers with poor credit, a secured credit card or even a retail credit account can help build credit scores because these are real credit cards that report your payment history monthly to the credit bureaus. On-time payment history and maintaining low credit balances will build your credit scores.

Prepaid transaction fees can add up quickly

Prepaid cards can help control your spending because a reloadable card only allows spending up to the amount you have pre-deposited. But the fees may not be worth it. By the time you add up the transaction fees, monthly charges, ATM fees and reloading fees; a traditional checking or savings account may be much cheaper. According to a study conducted by credit card comparison site NerdWallet, the average prepaid card costs nearly $300 a year in basic fees. The study was conducted using 40 prepaid card products.

Why prepaid cards are so popular

The prepaid card business is booming. The fees involved are lucrative and banks are heavily pushing them. JPMorgan Chase, American Express and many other big name financial institutions have thrown prepaid products into the ring. According to the Consumer Financial Protection Bureau, consumers are expected to load $167 billion onto prepaid cards this year. Prepaid cards do offer some benefits for consumers and some consumers are just feed up with banks and prefer prepaid products. But I think prepaid cards should be used temporarily, until a consumer is able to open a checking or savings account.

Insult to Injury

Prepaid cards are often marketed to low-income consumers who may already be living from paycheck to paycheck. What these consumers may not realize is that there are alternatives, such as no-chexsystems banks or second chance checking. Credit unions can be a great alternative to traditional banks. Find a credit union in your area.

A Chexsystems, EWS or Telecheck record is not the end of a banking relationship. First, there is a time-limit these consumer reporting agencies can maintain negative information; and second, the information may not be accurate which means it can be disputed.

It is insulting that a bank may decline a consumer a traditional account but turn around and offer their prepaid product. No thank you. Consumers with negative credit and negative banking records are not second class citizens. Consumers deserve a bail-out just like the big banks. Don’t let a bank dump their high-cost prepaid product on you. Review the fees before signing up, especially if they offer overdraft protection. Some prepaid debit card providers offer the same kind of “courtesy overdraft” that covers purchases when you don’t have the cash necessary to do it. The amount of the purchase is then deducted from the card’s balance as soon as more money is loaded on the card, along with a hefty fee.

Prepaid card full disclosure

Consumers are not always aware of the fees involved in prepaid cards. The biggest problem with prepaid cards is full disclosure. Some prepaid cards can be purchased in grocery stores or other retail establishments. Not until the consumer opens the welcome package do they find out what fees, costs and risks may be involved.

Consumers are often caught off guard when prepaid fees start rolling in; or worse, when the issuer puts caps on losses if the card is stolen. Costs and risks are not always transparent. In fact, not all transactions are handled in the same manner as a debit card from a bank account; for instance, paying at the pump may cause a hold of up to $75 when using a prepaid card. It may be too late, after you have already paid, only to find out a hold is on your prepaid card.

Even more shocking, some prepaid cards are not FDIC-Insured. That means your money is not guaranteed if the bank fails. This is something consumers should know upfront.

More protections coming

The Consumer Financial Protection Bureau is working on providing more protections for consumers using prepaid cards such as:

  • Requiring cardholders to consent before they’re signed up for overdraft or lending attached to prepaid debit cards, and making it against the rules for prepaid debit cards to automatically take loaded funds to pay off overdrafts.
  • Giving cardholders the same fraud protections credit card holders get.
  • Making sure cardholders’ funds are insured by the Federal Deposit Insurance Corp.
  • Standardized labels for prepaid cards that clearly lay out the card’s fees.

Recent Prepaid Card Complaints

According to the Consumer Financial Protection Bureau’s monthly complaint snapshot, as of Feb. 1, 2016, they handled approximately 4,300 prepaid product complaints. The RuchCard prepaid debit card generated a large number of the prepaid product complaints. In Oct. 2015 many RushCard customers were shut out of their accounts. Some customers did not have online or ATM access to their money for several weeks.

Here is a snapshot of prepaid complaints handled by the CFPB:

  • Inability to access funds on card: Consumers complained they were unable to access funds loaded on their prepaid cards for an extended period of time.
  • Prepaid cards re-issued without former balance: Consumers complained that when their prepaid cards expired, the company that issued the initial card often refused to re-issue a card with the remaining balance before their original card expired.
  • Account access problems when disputing particular charges: Customers who wanted to dispute an unexpected charge complained that after contacting the company about the issue, the entire balance on their card would be frozen while the claim was under review. The claim process could often take an extended period of time, during which the consumer would be unable to access important funds.
  • Fees when using prepaid cards: Some consumers complained about a wide variety of charges, including: monthly, inactivity, transaction, balance inquiry, PIN change, and overdraft fees.

Temporary solution

If you must use a prepaid card think of it as a temporary solution. The biggest issues I have with prepaid cards are: (1) Many are predatory, focusing primarily on low-income, low information consumers; and (2) They do not help build wealth. Consumers use their own money to load onto a prepaid card and get nothing in return. If you do not have a place to grow your money there is no way you can build financial stability for your family.

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