Consumers who took some economic hard knocks during the pandemic may be trying to repair their credit. MyFICO, the originator of FICO credit scores, is offering some advice when it comes to credit cards.
Having a credit card, keeping the balance low, and paying the bill on time, will boost your credit score in most cases but consumers should understand the difference between different types of payment cards.
Prepaid credit cards, sold in the gift card rack at retail stores, may look like a credit card and you can use it like one but it doesn’t do a thing for your credit score, according to the experts at MyFICO. Because you preload it with your own money it actually has nothing to do with credit and transactions are not reported to the credit agencies.
Here are key differences between a credit card and a prepaid card:
You do not need to fill out an application to open a prepaid credit card;
A lender will not check your credit report or perform a credit inquiry when you open a prepaid card;
Prepaid credit card accounts do not appear on your credit report with any of the major credit bureaus;
Prepaid credit cards are not considered in your FICO Scores.
Secured credit card
The reason a credit card is so important to your credit score is that it is an unsecured loan. The lender is trusting the borrower to pay it back. The lender wants to make sure the borrower is creditworthy.
For that reason, opening a credit card account may be difficult if you have a low credit score or no credit history. But MyFICO says there is an alternative — something between a credit card requiring a high credit score and a prepaid card, which at least allows you to make online purchases.
A secured credit card is similar to a prepaid card because the user is putting up their own money in advance. But there’s an important difference.
With a prepaid card, the consumer loads the card with cash and spends it until the balance is zero. With a secured credit card, the consumer deposits the cash with the lender. If the deposit is $500, then the credit limit each month is $500.
As long as the user makes the payment on time each billing cycle, they can continue using the card, keeping the balance below the amount of their deposit. If they don’t pay off the entire balance each month, the lender will charge interest — just as it would for a regular credit card.
Stepping stone to a regular credit card
Most lenders offering secured credit cards report payments to the credit bureaus. However, not all do, so it is worth asking when considering an application.
After using a secured credit card and making on-time payments for a year, many lenders will offer customers a chance to apply for a regular credit card and the deposit will be returned. At that point, a consumer should carefully consider the pros and cons of different cards, depending on what they purchase most.
A good place to start researching cards is the ConsumerAffairs Credit Cards Buyers Guide, which has thousands of verified reviews of a wide range of credit cards.