It's a classic Catch 22: how do you build a credit history if you can't get access to credit? Surprisingly a prepaid card could be the solution to your credit history problems.
If you’ve ever applied for some form of credit, your credit rating will have played an important part in whether your application was approved or rejected.
This rating is based upon your past history of borrowing and repayments, and is used by lenders to determine your ability to repay a debt and therefore the risk you pose to their money.
Those with a tarnished credit history or no previous experience of borrowing are faced with a classic Catch 22 situation: you need access to credit in order to build or repair your credit rating, but because of your past credit experience lenders are unwilling to lend to you.
There are a number of products on the market that are suitable for those who find it difficult to get credit, one such example is prepaid cards. Read our article What are prepaid cards? to find out more about how they work.
Prepaid cards - really?
The main advantage of prepaid cards for those with a poor credit rating is that unlike traditional credit cards or debit cards linked to a current account, a chequered credit history should not prevent you from getting one. This is because you can only spend as much as you load onto the card so you are not being given any form of credit facility. So you have a means of making card purchases online or in person and withdraw cash from an ATM even if you don’t have, or can’t get a credit or debit card.
However, what makes most prepaid cards so desirable for those who find it to get credit, is also their Achilles Heel when it comes to building a credit history. As there is no borrowing involved, you don’t improve your credit standing when you top up and make payments with them.
Until now, that is.
The clever part...
A number of providers now offer prepaid cards that could help you rebuild your credit history. This usually comes in the form of an add-on called ‘Creditbuilder’, for which you will be charged a monthly fee.
How it works:
- You agree to have the card for a set period of time, usually 12 months.
- You agree to pay a fixed monthly fee for the Credit building facility.
- You sign a loan agreement but don't actually borrow any money. Instead, this will usually be equal to the card's total Creditbuilders fees for the loan term.
- You agree to make a certain amount of credit available to prepaid card provider each month for the loan term - this will be taken as the loan repayment.
- The provider will report successful repayment of your loan to a credit reference agency.
For example: if you sign up with a card for 12 months with a useage fee of £5.00 per month, then your loan agreement would be for £60. The £60 would then be paid back monthly over a period of 12 months at £5.00 per month.
The £5.00 fee will be billed monthly, so you will need to ensure that you always have at least £5.00 in your account each month.
Every £5.00 fee taken from your account will then be credited against your 'loan' and the successful payments will be reported to the relative credit agency. By successfully paying back your loan in this way you should see at least some improvement in your credit rating.
The price you'll need to pay
Unfortunately, the credit building benefits of prepaid cards tend to come at a cost. Most have a whole host of fees attached, including: set-up fees when you take the card out, monthly ‘service’ fees, purchase fees each time you use your card, loading fees when you top up, cashpoint fees when you take out cash, inactivity fees if you don’t use your card for a while, foreign exchange fees and even cash-out fees if you want to cancel the card and have your money returned.
Not all prepaid cards will charge all of these fees, but most still come at a price. This is why it’s so important to think about how you would use the card and shop around for one with the lowest costs when you come to apply for a prepaid card.
The risk you'll do more harm than good
You should always carefully consider the benefits of any such services against their potential cost. If you think that there is a possibility of defaulting on your ‘loan,’ then rather than improving your credit rating you could end up damaging it even further – and paying for the privilege in the process!
Of course entering into another loan agreement when you have already got a patchy record with regards to handling credit, may not always be the best move. It may only be £60 a year, but by signing up with Creditbuilder you are still entering into a loan agreement.
Just as successful loan payments will register with the credit agency, so too will any missed or late payments. Default on your monthly payments and you could find yourself in a worse position than you were in before
It’s always important to check whether the prepaid card you are using is actually registering on your credit score. Look on the provider’s website or in their terms and conditions for details on exactly how they will pass on your information to the credit agencies..
As mentioned earlier, there are a myriad of different charges associated with prepaid cards. The good news for consumers is that not all prepaid cards charge the same fees, reflecting both the competitive nature of the prepaid card market and also how they cater to the different ways that we spend our money.
Think about what you will be using your prepaid card for: Will you be using it to spend overseas? Will you need access to cash? Or will you be using it for online purchases? By thinking in these terms and shopping around for the best deal, you should be able to find the right prepaid card for you at the right price.
What's the alternative?
A less expensive alternative to a prepaid card would be a credit building credit card, which tend to be more widely available to those with no or a low credit rating.
This acceptance of people who are seen as statistically more risky to lend to is counterbalanced by the significantly high interest rates applied to balances. However, if you’re looking to build your credit history this willingness to lend can be used to your advantage, but it will take self control.
To use these cards to your advantage you need to spend a little on the card each month and then repay it in full when you get your statement. Do this each month and you won’t pay any interest, as you won’t be carrying balances over, but you will be showing future lenders that you are able to sensibly use and repay credit. Over time this will help to create a more reliable picture of you on your credit history.
There are a number of other things you can do to try and boost your credit rating; read this article to find out more.
If you are finding it difficult to get standard forms of credit because you are struggling with unmanageable debt, then you might consider contacting your local Citizen’s Advice Bureau. As well as being independent and impartial, their advice can help you deal with your debt problems in simple steps such as drawing up a budget and prioritising your debts. Read our article on how to deal with debt for further advice.
