Prepaid card VS Credit card - What’s best?
Before deciding whether a credit or prepaid card is best for you, you'll need to have a good idea of how the two work. In a nutshell, to use a prepaid card, it must be preloaded, while with credit cards, you're essentially using borrowed money. Plus, there are pros and cons to both. For example, prepaid cards might be easier to get, but card fees can quickly add up. While credit cards can provide protection on your purchases, excessive spending may make it hard to pay back borrowed money.
Once you know how each works, the advantages and disadvantages, it's a matter of deciding what card best suits your lifestyle, habits and what will save you money in the long run.
What about "prepaid credit cards"?
What's best: prepaid cards or credit cards?
What's a prepaid card?
A prepaid card is preloaded with money before you can use it. Generally, there are no overdrafts or credit facilities, so once you've used up the balance, you will need to top it up. It's relatively easy to apply for one, they can be helpful budgeting tools, and many come with handy benefits. However, there are limits and cost to watch out for.
What are the pros of prepaid cards?
1. Easy to apply and use
It's relatively quick and easy to apply for a prepaid card as there are no credit checks, so you're unlikely to be rejected even if you have a bad credit history. Prepaid cards can be an alternative if you are struggling to get a regular current account; for example, you have recently moved to the UK.
2. Handy budgeting tool
Prepaid cards allow you to spend the money you have loaded to your card, so there is less chance of overspending. As a result, you may find a prepaid card a handy way to limit your monthly shopping spend. Additionally, many come with a handy app that allows you to set up budgeting goals and track your progress.
3. Added perks
There are different types of prepaid cards. For example, multicurrency cards such as Wise and Currensea are an ideal type of prepaid card for holidays abroad, as they offer competitive exchange rates.
Some are great for shopping as they offer you cashback. For example, the Pockit card offers 3% cashback at Sainsbury's and 4% at Argos. Others can help with your family’s budgeting. For instance, with the Nimble prepaid card, you can add pocket money and teach your child good money habits.
You can compare all of the cards mentioned above as well as others, on our prepaid comparison page.
What are the cons of prepaid cards?
1. Your money is not covered by the FSCS
The Financial Services Compensation Scheme (FSCS) protects deposits paid into banks, building societies or credit unions should these go bust, covering up to £85,000 per person. Prepaid card accounts fall under E-money or electronic money. The FSCS does not cover E-money (such as prepaid cards and prepaid accounts) as this is considered a method of payment rather than a deposit in a bank.
TIP: There is a level of protection on prepaid cards. However, as the FSCS does not cover these, there is a risk, particularly for more considerable sums of money.
2. Limitations
Prepaid accounts will often come with limitations or restrictions. For example, there will likely be a limit on the amount of money you can have on your card, as well as spending caps. It's also likely you won't be able to use your prepaid card at self-service petrol stations or pumps. Some hotels may decline your prepaid card to make a reservation, and most airlines won't accept a prepaid card to make purchases onboard.
If improving your credit score is important to you, a prepaid card won't be of any real assistance. As mentioned before, there is no credit facility, so your ability to pay back borrowed money cannot be assessed by any of the three main UK credit bureaux. Some cards do come with credit builder tools that can help with improving your rating.
3. Fees
When looking for the best UK prepaid card options, fees and charges are certainly something to factor. In recent years and due to competition, many providers have improved on card fees. Fees you may want to compare and look out for include:
- Application fee (also called setup fee)
- Admin fee (normally charged monthly)
- ATM fees (the UK and abroad)
- Transaction fees
- Top-up fees
- Replacement card fee
- Inactivity fee (also referred to as dormancy charge)
What's a credit card?
Credit cards allow you to make purchases with "borrowed money". Put simply, when you buy something using your credit card, your credit card company makes the payment on your behalf. Your credit card company will bill you for the purchase, normally at the end of each month. Until the money is paid back, you will owe them that money.
While credit cards have many benefits, such as purchase protection and improving your credit score, it's a form of debt. If you don't pay back what is owed to your credit card company in full, they will charge you interest. If you don't control your credit card spending, you may find it hard to make payments when due, and failed payments can severely damage your credit score.
What are the pros of credit cards?
1. Protection for purchases made on credit cards
Purchases made between £100 and £30,000 using a credit card (whether in part or in full) are protected under Section 75 of the Credit Act 1974. This means your credit card company covers you should there be a problem with the retailer delivering services or products purchased with your credit card. It covers your purchases even if the retailer or trader goes bust.
2. Helps improve your credit score
A good UK credit score means lenders are more likely to lend to you. A good credit score may give you access to better credit deals, for example, a wider range of personal loans at a lower interest rate. Making sure you manage your credit card well, for example, keeping clear of your credit card limit and keeping up with payments, can help improve your credit score.
3. Lower interest rates and rewards
There are many types of credit cards. For example, “interest-free credit cards” allow you to make purchases without attracting interest for a prolonged period, usually 3 to 28 months. "Zero balance transfer credit cards" will enable you to take your existing card balance to another credit card that does not attract interest for a period of time.
There are also rewards credit cards, that "reward" you for usage. For example, you earn Avios points or air miles with the British Airways American Express card. Or with the Lloyds Bank Cashback credit card, you earn 0.25% to 0.5% cashback (depending on your annual spend) and up to 15% cashback with retailer offers when you shop with the Santander All in One Credit Card.
If you plan to a use rewards and cashback card beware that some offers are subject to change and points saved can expire, so be sure to keep an eye on these.
What are the cons of credit cards?
1. Credit card interest can be expensive
Interest is charged if you don't pay off what you owe in full when due. Even if you make the minimum payment amount required by your credit card company, you will still be charged interest for the total amount you owe. Debt can start to build up if your card balance is carried over from month to month, with interest being charged to your overall balance. Or worse, your credit card debt could get out of control.
2. Credit card cash withdrawals are costly
Avoid making cash withdrawals using a credit card. There are nearly always withdrawal fees. Plus, you will likely be charged interest immediately (and often at a higher interest rate than interest rates on purchases) from the day of the withdrawal until the money is paid back. There are other transactions your credit card company could consider being equivalent to withdrawing cash, for example, paying a utility bill, mortgage payment or buying travellers' cheques.
TIP: As a general rule, avoid using your credit card to withdraw cash. Paying utility bills, making mortgage payments, buying traveller's cheques, betting and gambling with your credit card can be considered cash advances or withdrawing cash.
3. Failed payments can damage your credit score
Failing to pay at least the monthly minimum amount will result in a late fee and your credit score being negatively marked with a missed payment. A lender will likely see your late or missed payment as a risk and sign that you are struggling financially. Even if a lender lends to you, you may find the cost of borrowing expensive and the choice of products available to you limited.
If you are struggling to control spending and debt, or have struggled in the past, you may want to avoid using credit cards.
What about "prepaid credit cards"?
Although you may find many websites using the term "prepaid credit cards”, they do not exist in the UK. Credit is the ability to make a purchase and pay for it later. While prepaid means paid in advance or, in the case of a prepaid card, pre-loading money before you can use it. Prepaid cards normally fall under E-money, and credit cards are a form of credit or borrowing. These are two distinct functions.
There are prepaid card providers who do have some form of credit based facilities, however these are normally add-ons or they are provided by a third party. For example, some prepaid card providers offer a credit builder service, which is designed to improve your credit rating by making small repayments. However, as mentioned before prepaid credit cards don’t exist.
What's best: prepaid cards or credit cards?
It is down to you, but we suggest you first think about your lifestyle and spending habits. Also, think about your financial limitations, where you might be struggling or need to improve.
For example, if you are looking for an everyday card without worrying about overdrafts and interest rates, a prepaid card might be for you. If you are a student or new to the country and are struggling to get a regular current account, then a prepaid card might be the best temporary solution. If you are looking to improve your credit score and already have a good financial footing, you may want to consider moving away from using a prepaid account.
If you know you have a good credit score, are disciplined, and you're confident you'll stick to paying off your credit card, then applying for a credit card might be a better option for you. Plus, you'll have the added benefit of Section 75 purchase protection. But, if you know you tend to overspend or have struggled with debt, you may want to think twice before applying for a credit card.
Also, think about the long term cost. Prepaid card fees may seem small, but with continuous use and over time, these fees will add up. Credit cards are not expensive if you avoid cash withdrawal charges and pay your balance in full to avoid the interest charges. There is always the danger of not paying the balance in full and the outstanding balance plus interest snowballing out of control.
Summary
We’ve looked at the basic differences between prepaid and credit cards. We also looked at the main benefits and dangers that you should be aware of when deciding what is best for you. Know your tendencies and consider the costs - particularly when it comes to credit cards. If you're not disciplined in your spending and you fail payments, credit cards can be very costly to both your pocket and credit score. Keep in mind too that the FSCS does not cover E-money accounts.
And our final tip: always shop around and compare. We have made it easy to compare credit cards and compare prepaid cards. There are no forms to fill in, and MustCompare is completely free to use.
While prepaid credit cards in the UK don't actually exist, there is an alternative. Be sure to read our article: Debit cards VS Prepaid cards guide.