The Hidden Benefits of Secured Cards

Secured cards can help users build their credit.

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The wide variety of credit card offers can be bewildering. One of the questions I hear a lot is about the difference between a secured credit card and a prepaid credit card. Particularly for those trying to build their credit, it can be a challenge understanding your best options. And to make matters worse, making the wrong choice can have a big impact on your efforts to build good credit.

So let’s take a brief look at each card, and then will discuss how they can impact your credit.

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Secured Credit Cards

Secured credit cards work much like a traditional card, but with one big exception. Before using the card, you must deposit cash with the credit card issuer. The issuer then holds the deposit as security for future credit card payments. Importantly, you must make your monthly payments on the card; the security deposit is there to protect the credit card company in case you don’t make your payment.

The credit limit on a secured card typically is equal to the amount of your deposit. Deposits generally can range from a few hundred dollars up to $5,000 or more, depending on how large of a credit limit you want. And payments (or non-payment) are reported to the three major credit bureaus.

If you are looking for the best secured credit card, look for those with low fees. Fees typically range from about $10 to $30 a year. Your deposit is held in a non-interest bearing FDIC-insured account. The card issuer will refund the deposit when you close your account.

Prepaid Credit Cards

With prepaid credit cards, you must also deposit funds before using the card. The difference is that the issuer does not hold the deposit as security for future payments. Instead, each transaction or withdrawal you make reduces the balance you placed on the card. In this way, a prepaid card is very similar to a bank debit or ATM card.

Unlike a secured credit card, however, transactions with a prepaid card generally are not reported to the three major credit bureaus. While certain types of payments, like rent, are reported to a credit agency by some prepaid card issuers, the three major credit bureaus that impact your FICO score (Experian, TransUnion and Equifax) generally do not track non-credit related payments.

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Which one helps improve your credit?

From the above descriptions, it should be clear that if you want to improve your credit score, a secured card can help while a prepaid card generally cannot. In fact, for people if have recently gone through bankruptcy, foreclosure, or other financial hardships, a secured credit card may be one of the only ways to begin restoring your credit. In fact, this was the suggestion of Liz Weston, who literally wrote the book on credit scores.

In contrast, a prepaid credit card for the most part won’t help you build your credit. Prepaid cards can be a great way to get the convenience of a credit card without the fees of bank. But they won’t help you build your credit.

DR is the founder of the popular personal finance blog, the Dough Roller and credit card review site, Credit Card Offers IQ.