The growth in the use of prepaid debit cards over the past several years has been impressive.
In fact, an industry that was once populated exclusively with issuers you’ve likely never heard of has attracted the biggest names in banking.
We can thank the fee-based income generated by prepaid debit cards for the addition of so many new players.
One of the ongoing public relations problems facing prepaid debit cards, in addition to the punishing fee structures present in many of the card options, is their lack of any credit building benefit.
Prepaid debit cards are not credit products. As such, they are not reported to the credit reporting agencies like, for example, credit cards and loans.
Prepaid debit cards are not “applied for”, but rather they are simply purchased, like a turkey sandwich.
There is no extension of credit because you are responsible for loading your own funds onto the card. There is no due date because there is no payment due.
There is no interest because there is no balance being carried from one month to the next. And finally, there are no approvals or declinations because there is no underwriting.
Why Credit Agencies Don’t Report Prepaid Cards
These might all sound like they’re benefits of prepaid debit cards, and in some cases you’d be right.
But, if you ever wanted to actually borrow money to buy a home, a car or finance an education then the prepaid debit card isn’t going to help you.
The credit reporting agencies do not want them on their credit reports, and for good reason.
Credit reports are called credit reports for a reason. Their purpose is to maintain credit related obligations and liabilities.
Prepaid debit cards are neither credit obligations nor represent liability. That’s why they are not, and have never been, reported to the credit reporting agencies.
Prepaid debit cards represent consumers using their own money rather than using a bank’s extension of credit.
It’s really no different than using cash, writing a check, using a traditional debit card that’s tied to a checking account, or using a gift card that you received for Christmas.
It’s simply a cash based transaction.
The Difference Between Debit Cards and Prepaid Debit Cards
The only possibility for a debit card to be reported to the credit reporting agencies is when it’s actually a debit card, not a prepaid debit card.
And, the debit card has to be backed by a line of credit or overdraft protection, which are actual forms of credit.
The credit reporting industry does not want prepaid debit cards on their credit reports and their credit reporting standards guidelines have made that clear, “Do not report prepaid/gift cards because the consumer has no credit obligation.”
The Cheapest Way to Build Credit
Some have argued that prepaid debit cards SHOULD be reported to the credit bureaus so they can help you to build a credit report and a credit score.
That argument seems counterintuitive because prepaid debit cards are used by consumers who A) can’t get traditional credit cards because of previous mismanagement, or B) don’t want a credit card because they don’t want to get into debt.
Arguing that prepaid debit cards should be on credit reports seems to suggest that the consumer wants it there so that they can get credit.
Additionally, just because something is on a credit report doesn’t mean it’s going to be considered by credit scoring systems. It doesn’t work that way.
Credit scoring systems are software and the software has to be programmed to consider newly added items.
Take residential rental accounts for example. They are occasionally reported to Experian but they are not considered by FICO’s credit scoring systems.
So, they do you no good to improve your FICO scores.
NOTE: rental accounts are considered by VantageScore’s credit scoring models.
If your goal is to build solid credit history, one that can be used for a lifetime of competitive financing options, then the credit card is still the best and cheapest option.
In fact, the credit card is one of the only credit products where debt, interest, and fees are optional.
You can’t take out a home loan, a car loan, a student loan or any other type of loan without actually being in debt.
You can open a credit card and have no costs associated with the use of the plastic, and you won’t have to worry about whether or not they’re helping your credit reports and scores because it will be automatic.
John Ulzheimer is the Credit Expert at CreditSesame.com, and a credit blogger at SmartCredit.com, Mint.com, and the National Foundation for Credit Counseling. He is an expert on credit reporting, credit scoring and identity theft. Formerly of FICO, Equifax and Credit.com, John is the only recognized credit expert who actually comes from the credit industry. The opinions expressed in his articles are his and not of Mint.com or Intuit. You can follow John on Twitter here.