Can Prepaid Credit Cards Help Build Credit?

A credit score is a three-digit number that provides lenders with an immediate assessment of an individual’s financial health. It plays a significant role in determining access to loans, interest rates, and even housing opportunities. Many individuals aim to establish or improve their credit. This article clarifies whether prepaid credit cards can help in achieving this goal.

Understanding Prepaid Cards

A prepaid card functions much like a debit card, allowing users to spend only pre-loaded money. Funds are deposited in advance, and transactions draw directly from this balance. Unlike traditional credit cards, prepaid cards do not involve borrowing money or extending a line of credit. They are not a loan product, with no credit limit to manage or debt to repay. Prepaid cards operate on a “pay-as-you-go” basis, making them distinct from credit products.

How Credit Scores Are Built

Credit scores are primarily built through the responsible management of borrowed money. Several factors influence a credit score, with payment history being the most significant component, typically accounting for about 35% of the score. This factor reflects whether payments are made on time.

Another important factor is the amounts owed, often referred to as credit utilization, which represents the percentage of available credit being used. Keeping credit utilization low, generally below 30%, is beneficial. The length of one’s credit history, including the age of accounts, also contributes to the score. Additionally, new credit applications and the diversity of credit types used (e.g., installment loans, revolving credit) also play a role in score calculation.

Prepaid Cards and Credit Reporting

Prepaid cards generally do not assist in building credit because their activity is not reported to the major credit bureaus: Experian, Equifax, and TransUnion. Since these cards do not extend credit, there is no payment history or credit utilization to track and report. Because prepaid cards are not extensions of credit, they do not fall under traditional credit reporting requirements. Consequently, responsible use of a prepaid card will not positively or negatively impact a credit score.

Credit Building Alternatives

Individuals seeking to establish or improve their credit have several alternatives. Secured credit cards are a common option, requiring a cash deposit that typically serves as the credit limit, often starting around $200. This deposit acts as collateral, reducing risk for the issuer, and responsible payment activity is reported to the major credit bureaus, helping to build credit history.

Becoming an authorized user on another person’s credit card can also contribute to credit building. When the primary account holder manages their card responsibly, making on-time payments and maintaining low balances, this positive activity can appear on the authorized user’s credit report.

Another option is a credit builder loan, where the borrowed money is held by the lender in a savings account or certificate of deposit while the borrower makes regular payments, usually over 6 to 24 months. These payments, typically ranging from $300 to $1,000, are reported to credit bureaus, allowing individuals to demonstrate a history of timely payments and build credit.