Can You Build Credit With a Prepaid Credit Card?
Uncover whether prepaid cards build credit and explore proven methods to effectively establish or improve your credit history.
The question of whether a prepaid credit card can help build credit often stems from a misunderstanding of how credit operates and the differences between payment tools. This article clarifies why prepaid cards are not suitable for credit building and outlines effective strategies for establishing a positive credit history.
Understanding Prepaid Cards
A prepaid card functions like a debit card, allowing users to spend only pre-loaded money. Users deposit their own funds, and the spending limit is restricted to that amount. This means no borrowing from a financial institution. Prepaid cards are reloadable and can be used for purchases online or at physical merchants, similar to traditional payment cards.
Prepaid cards do not build credit history because they involve no borrowing or credit extension. Financial activity with these cards is not reported to major credit bureaus. Without debt to repay, there is no payment history for bureaus to track. While convenient for managing spending, prepaid cards offer no direct benefit for credit score development.
How Credit is Built
Credit is established by tracking an individual’s borrowing and repayment behavior. The three major credit bureaus—Experian, Equifax, and TransUnion—collect data on your credit activity. This information generates credit reports and scores, which lenders use to assess creditworthiness and risk.
Credit scores, such as FICO scores, are calculated based on several factors:
Payment history (35%): This is the most influential factor, emphasizing on-time payments.
Amounts owed (30%): Also known as credit utilization, this reflects how much of your available credit is used.
Length of credit history (15%)
New credit (10%)
Credit mix (10%): This considers different types of credit accounts.
Consistent, responsible borrowing and repayment across these categories builds a positive credit profile.
Effective Credit-Building Options
Several effective alternatives exist for building or improving credit that report activity to credit bureaus. Secured credit cards are a common starting point, requiring a cash deposit that often acts as the credit limit. This deposit serves as collateral, reducing issuer risk. Consistent on-time payments are reported to credit bureaus, building positive payment history. Many secured cards eventually allow cardholders to transition to an unsecured card and have their deposit returned after demonstrating responsible use.
Credit builder loans are another option, offered by credit unions or community banks. The borrowed amount is placed into a savings account, inaccessible until the loan is fully repaid. Regular payments are made over 6 to 24 months and reported to credit bureaus. Once paid off, funds are released to the borrower, providing credit history and a small savings fund.
Becoming an authorized user on another person’s well-managed credit card can aid in credit building. The primary cardholder’s positive payment history can reflect on the authorized user’s credit report, potentially boosting their score. This strategy relies entirely on the primary user’s responsible financial behavior, as their missteps could negatively impact the authorized user’s credit.
Some services allow individuals to report on-time rent and utility payments to credit bureaus. While not all landlords or utility companies report directly, third-party services can submit this information, adding positive payment history to your credit file. This benefits those with limited traditional credit accounts, offering another way to demonstrate financial responsibility.