Credit Cards

How prepaid credit cards work

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Last updated on January 4, 2021
prepaid credit cards

This post is written by Barry Choi, founder of Money We Have, and personal finance and travel expert.

Credit cards have become a part of our daily lives. Just about everyone has one and most retailers will typically accept credit cards as a form of payment. It’s actually hard to imagine life without a credit card.

But here’s the thing, not everyone wants a credit card or qualifies for one. Are they out of luck since some merchants have gone cashless? Not exactly. Many debit cards are now linked to the Visa or Mastercard networks, so you can make purchases in-store and online with your card.

While debit is a great solution, there are no benefits or rewards. A better solution might be to use a prepaid credit card. No, I’m not talking about those cards you get at the gas station or gift cards, I’m talking about all the new fintech companies that offer prepaid cards. Here’s how prepaid credit cards work.

What is a prepaid credit card?

As the name implies, prepaid credit cards are credit cards that you load with funds. Let’s say you get a prepaid credit card and load $250 on it, you would then be able to charge $250 to your card. Your limit is whatever you’ve loaded onto the card. You can not go into overdraft with prepaid credit cards. There is also no interest-free period since you’re paying in full each time.

Some prepaid credit cards have a fixed amount, while others allow you to reload them as often as you like. You would then be able to use the card wherever the network is accepted. E.g. a prepaid Mastercard could be used anywhere Mastercard is accepted.

Prepaid credit card fees

Here’s where things start to get a bit tricky. Every prepaid credit card had different fees. For example, let’s say you’re buying a prepaid Visa that you get from the gas station or drug store. That card may have an activation fee of $6.95. If you were to buy a $100 card, it would actually cost you $106.95.

There are also some prepaid credit cards that charge you an activation fee, monthly fee, reload fees, bill payment fees and more. Yes, that’s a lot of fees you need to pay, so you need to read the fine print before you purchase them. Even if you don’t use the card, you could end up paying monthly fees that would eat into your balance.

Fortunately, there are some no fee prepaid credit cards such as KOHO. With KOHO, you can get the basic service at no cost. You sign up via the app first, and then a physical card is mailed to you. You can then reload your card via e-Transfers (assuming you have access to free e-Transfers) and direct deposits for free.

Benefits that come with prepaid cards

Generally speaking, only fintech prepaid credit cards come with any benefits that are worthwhile. For example, KOHO gives you 0.5% cash back on all purchases and you can also set up automated savings goals. That may not sound like much, but considering traditional prepaid cards will typically give you nothing, earning cash back with KOHO is sweet

stack credit cardSTACK Mastercard is a prepaid credit card with no foreign transaction fees. With most credit cards, you pay a 2.5% fee when you make purchases in any currency besides Canadian dollars. However, with STACK, you pay the spot rate. This also applies to ATM withdrawals (minus any fees the ATM itself may charge). As you can see, this is a good benefit for travellers or people who shop online at retailers who charge US dollars.

Prepaid credit cards are different from secured cards

Some people confuse prepaid credit cards with secured credit cards. With secured cards, you deposit security funds to show that you’re creditworthy. That security deposit can not be used to pay off your balance.

The other major difference between secured credit cards and prepaid credit cards is that secured credit cards report your credit history to one of the credit bureaus, so you can improve your credit score. Prepaid credit cards do not report your credit history. If you relied just on a prepaid credit card, your credit score wouldn’t improve.

Why people choose prepaid cards over traditional cards

Okay, so prepaid credit cards may have fees, you get limited benefits, and they don’t report to the credit bureaus. Why would anyone choose them over travel or cash back credit cards? The answer is simple when you think about it.

Not everyone wants to have or can get a traditional credit card. Some people realize that a credit card causes them to overspend, by switching to a prepaid card, they’ll only charge what they can afford. There are also some people who may not qualify for a regular credit card because they have a low credit score. Prepaid credit cards don’t require a credit check, so they can get one and make purchases where credit cards are accepted.

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