Do Prepaid Credit Cards Help You Build Credit?

Prepaid credit cards are often misunderstood regarding their ability to build credit. While they offer a convenient way to spend your own money, they do not build credit. This article clarifies what prepaid cards are, explains how credit scores are calculated, and introduces effective tools for building credit.

Understanding Prepaid Cards

Prepaid cards operate by allowing you to load your own funds onto the card, which you then use for purchases or withdrawals. They function similarly to a debit card or a gift card, where your spending is limited to the amount you have pre-deposited. Unlike traditional credit cards, prepaid cards do not provide a line of credit or involve borrowing money from a lender. Instead, you are spending your own money that has been loaded onto the card in advance.

Because prepaid cards do not involve borrowing or repayment, there is no credit activity to report to the major credit bureaus: Experian, Equifax, and TransUnion. Credit bureaus track how individuals manage borrowed funds. Since prepaid cards do not entail borrowing, their use does not contribute to your credit history or credit score. While they offer an alternative to cash for transactions, they cannot serve as a tool for credit building.

How Credit Scores Are Built

Credit scores are numerical representations that indicate your creditworthiness, reflecting your history of borrowing and repaying money. These scores are compiled by the three main credit bureaus, which collect and maintain your financial information. Lenders use these scores to assess the risk associated with extending credit, influencing decisions on loan approvals and interest rates. Building a strong credit score requires consistently demonstrating responsible borrowing behavior over time.

Several factors contribute to the calculation of a credit score, with varying weights depending on the scoring model used, such as FICO or VantageScore:
Payment history (35-40%): This is the most significant factor, reflecting whether you pay bills on time.
Amounts owed, or credit utilization (30%): This evaluates the proportion of available credit you are currently using. A lower utilization rate, ideally below 30%, is generally viewed more favorably.
Length of credit history (15%): This considers how long your accounts have been open.
New credit (10%): This reflects recent credit applications and newly opened accounts; frequent applications can sometimes signal higher risk.
Credit mix (10%): This assesses the diversity of your credit accounts (e.g., installment loans and revolving credit), showing your ability to manage various types of debt responsibly.

Building Credit with Other Tools

For individuals seeking to establish or improve their credit history, several legitimate financial products and strategies are effective. Secured credit cards are a common starting point, particularly for those with limited or no credit history. These cards require a refundable security deposit, which typically sets the credit limit, and their activity is reported to the major credit bureaus, allowing for credit building through responsible use. Consistent on-time payments and keeping the balance low are important for positive reporting.

Credit builder loans offer another structured approach to establishing credit. With this type of loan, the lender deposits the loan amount into a locked savings account or Certificate of Deposit (CD) that you cannot access until the loan is fully repaid. You make regular monthly payments, and these payments are reported to the credit bureaus, building a positive payment history. Loan amounts typically range from $300 to $1,000, with terms often between six to 24 months.

Becoming an authorized user on another person’s credit card account can also contribute to credit building. When you are added as an authorized user, the account’s payment history and credit limit may appear on your credit report. This can be beneficial if the primary cardholder maintains a history of on-time payments and low credit utilization, as their responsible behavior can positively reflect on your credit profile. However, it is important that the primary cardholder manages the account responsibly, as their negative actions could also impact your credit.