Gettting from Prepaid to Postpaid

Today’s post is a guest post from Tim Chen, CEO of NerdWallet. Tim writes about credit cards for the Forbes Moneybuilder Blog, Huffington Post, and the Christian Science Monitor.

For those with limited credit or bad credit, prepaying for services is a fact of life. This can include cell phone bills, debit cards, secured credit cards, and even cable service. However, while some of these prepaid services help you tread water, few of them actually help you build credit.

Now if you need to rent a car or buy something online with no credit history, there are really only two options for using plastic. You can either go with (i) a prepaid debit card, which you load money onto like a gift card, or (ii) a secured credit card, which requires you set aside upfront collateral at the bank, but after which works just like a normal credit card.

These two types of cards have very different fee structures and very different pluses and minuses.  But the secured credit card option is a rare way to prepay and still build credit. It’s a much better alternative than going with a prepaid debit cad, which we’ll explain in great detail below.

At first, the two types of cards work in a similar manner. Generally speaking, you must have a social security number to open an account. Then you put in a few hundred bucks, and get a credit line (secured credit card), or debit card balance (prepaid debit card) equal to the amount you put in.

However, after you spend money on a prepaid card, you have no obligation to pay it back, since it’s subtracted directly from the balance. That’s not the case with a secured credit card – you must pay what you spent at the end of each month, or else you will get charged late fees and interest, just like a normal credit card, despite the fact that they are holding your upfront deposit.

Pros of Prepaid Debit Cards

– No obligation to pay back money spent each month, on top of what you already put in upfront, so you can’t overspend.

– Ability to receive direct deposits and use in-network ATMs for free, though if these are your priorities, our analysis of debit cards vs checking accounts shows its cheaper to just get a checking account.

Pros of Secured Credit Cards

– Build a credit history.

– Lower fees, if you get one from a big national bank. While shady online secured cards have huge fees, you can generally get one from your local bank with a $30 or lower annual fee. That’s not bad compared to prepaid cards, which typically have $3-6 per month maintenance fees, and charge $3-6 each time you reload the card, not to mention ATM fees, balance inquiry fees, and activation fees.

– If you get a secured card from your local bank, expect to be offered an unsecured credit card after 12 to 18 months of good behavior. With continued good behavior on an unsecured card, you will start to qualify for high-end cards like 0% balance transfer cards and cash back credit cards.

– Avoid getting ripped off. Despite what they might claim, prepaid debit cards leave you exposed to all sorts of fraud and the risk of mysteriously vanishing money, fraud, and loss via merchant disputes, as hundreds of complaints about the nation’s largest prepaid card issuer would suggest. The complaints about customer service are simply horrifying.

The credit that a secured credit card helps you build or rebuild will open up new doors for you. It allows AT&T to offer you a “postpaid” cell phone plan, it allows banks to issue you a credit card, and one day down the road it could help you secure a car loan or home loan.

A Secured Card + Checking Account Beats a Prepaid Debit Card
Based on normal use, prepaid debit cards are more expensive than checking accounts. We conducted a hypothetical test, where we compare checking account fees at the 10 largest checking account providers, versus fees for 10 popular prepay cards, including the most popular one in America, the WalMart MoneyCard. The average prepaid debit card costs $19.14 per month, and the average checking account costs $6.82 per month. We explain how we calculated these numbers in the appendix.

Thus, we recommend that you get a secured card and checking account, rather than relying on check cashing services combined with a prepaid debit card. In both cases you have no privacy, as they require social security numbers. But the secured credit card & checking account gives you better protection and costs less, while building credit.

*Appendix
For prepaid debit cards, we assumed your monthly usage would include 1.5 ATM withdrawals, 8 purchases, 2 reloads, and 1 balance inquiry. We compared cards from Green Dot, Walmart MoneyCard, NetSpend Visa, Emerald Card, Rush Card, Vision Premier, Western UnionMoneyWise, AccountNow, ACE Cash Express (NetSpend), and PayPower.
For banks, we assumed your initial checking account would start with $100, and that you would use an out of network ATM once a month. We compared checking accounts from Bank of America, Capital One, Chase, Citi, HSBC, PNC, SunTrust, TD Bank, US Bank, and Wells Fargo.

About NerdWallet
NerdWallet helps you find the best credit card, by sorting nearly 600 credit cards by best rewards and lowest APRs. 

Ben Edwards, the founder of Money Smart Life, saved up enough to buy a Nintendo back when he was 12 years old. When he used the money to buy shares of Wal-Mart stock instead, he knew he wasn't like the other kids... His addiction to personal finance has paid off for his family and now he's helping you to afford the life that you want. Check him out on the web at Google Plus, Twitter and Facebook.

All posts by Ben Edwards