Prepaid Cards: What's the Catch?

Prepaid debit cards are currently all the rage. These cards are sold at gas stations, grocery stores, drug stores and office supply stores, and several celebrities are creating branded cards with their names.

For some people, prepaid cards offer a solution to their struggles with credit card debt. Since prepaid cards are not credit cards, cardholders will not go into debt while using them (though it’s still advisable to stick to a budget). Considering all of the success and popularity of these products, many people wonder: What’s the catch?

1. Fees

Between activation fees, monthly fees, reload fees and ATM withdrawal fees, prepaid card users have a lot of possible pitfalls they’ll want to avoid. You can find prepaid cards with fewer fees than others, so be sure to check out the fee schedule in the cardholder agreement before signing up. In contrast, there are still plenty of credit cards offered with no annual fee, and those who avoid interest by paying their balance in full each month can use these products for years without having to pay any fees.

2. Rewards Programs

There are many credit cards that offer rewards for spending in the form of valuable points, miles or cash back. In fact, credit card issuers commonly offer new applicants generous sign-up bonuses worth hundreds of dollars, just for giving them a chance to earn your business. Occasionally, prepaid cards can offer some basic rewards for purchases from select merchants, but these programs pale in comparison to the most competitive rewards programs offered by major credit card issuers.

3. Security

There are some protections that prepaid card users have against fraud, but they must first try to prove the fraud and recover their losses. And even if they are ultimately successful, prepaid cardholders may not have access to their funds for some time. Whereas with a credit card dispute, the card issuer immediately issues a credit for the amount in question, and then performs an investigation. Furthermore, prepaid card users cannot request a chargeback once they have authorized a transaction. So if a merchant fails to deliver, or goes out of business, the prepaid card issuer cannot offer them any recourse.

4. Prepaid Cards Don’t Build Credit

Since there is never any loan with a prepaid card, it is not considered to be a line of credit and it will not contribute to your credit history with the major credit bureaus. Only a credit card, a loan or another line of credit will help you build your credit history and raise your credit score. (Although some credit scoring models factor in some alternative credit data — like rent and utility payments — it is currently not standard practice across the industry.) This is important to those who might want to apply for a car, home or student loan. In addition, your credit history can be a factor in setting insurance rates and in some pre-employment screenings.

Even if you opt to use a prepaid card instead of credit, it’s important to check your credit reports and credit scores regularly to make sure there are no errors, or no unpaid debts that are dragging down your scores. You can check your credit reports for free once a year from each of the three major credit reporting agencies, and you can check your credit scores for free on Credit.com, which updates your scores monthly.