When a Prepaid Card is Worth the Fees

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Some people love their prepaid cards. They work great for Credit.com reader Jack Sauber, who says that “credit cards are great but it is like an open wallet for certain kids,” whereas “prepaid cards have … better control.”

Meanwhile, other people allege that any prepaid cards come with hidden fees, which can severely hurt people with low incomes.

“Failing to disclose fees is essentially stealing money from consumers,” Florida Attorney General Pam Bondi said in a press release announcing her investigation into five large prepaid card companies.

Who’s right? Maybe they all are. Prepaid cards offer convenience and a way to control spending money, especially for consumers who don’t have a bank account. But some also come with fees and cumbersome processes for first-time users that can make them less attractive.

“They can be OK for certain people if you’re looking for a convenient way to manage your cash flow,” says Gerri Detweiler, Credit.com’s consumer credit expert. “Just watch out or the fees.”

With a prepaid card, consumers load money into an account tied only to the card, and do not require a bank account. Sometimes cards come pre-loaded with specific dollar amounts, and other times the consumer decides how much to load. Prepaid cards give consumers the opportunity to withdraw cash from ATMs, make purchases online, and also to buy things at retail stores using the same terminals used for swiping credit and debit cards.

Demand for prepaid cards has increased dramatically in recent years, and is expected to continue to grow. Prepaid cards generated $290 billion in revenue in 2009, a figure that is expected to balloon to $791 billion by 2014, according to a study by Markets and Markets, a market research company.

Demand may be especially strong among people who are “unbanked” or “underbanked” (the latter referring to people who have low bank balances, and resort to costly services like money transfers or payday lenders for a significant portion of their financial needs). Over 28 percent of American families are un- or underbanked, according to the FDIC.

For those people, the opportunity to use a large bank’s ATM network, or limit their spending to whatever amount they preload onto the card, can be important and helpful features.

“Realistically, for folks on a tight budget, sometimes a prepaid card is the only thing they can use,” Detweiler says.

The other major benefit of prepaid cards is safety. Unlike cash, which obviously comes with no protection for the consumer if it’s stolen, in many cases “prepaid cards carry the same fraud liability protections as debit cards,” Detweiler says. It’s important to check the issuer’s policy on this, however, since some cards do not offer such coverage from fraud.

Prepaid cards come with potential pitfalls. Some cards charge a fee every time a consumer withdraws money using an ATM. In the case of a bank like Chase, which recently announced its own line of prepaid cards called “Liquid,” the bank is making money off of prepaid customers in two ways.

“This is a fee Chase is charging, basically for the privilege of letting the bank hold on to your money and lend it to other customers,” Rich Smith, aka The Motley Fool, wrote in AOL DailyFinance.

As if paying for the right to use you own money weren’t enough, some prepaid cards also charge monthly fees, inactivity fees, overdraft fees, and fees to talk to a customer service representative, according to Lauren K. Saunders, managing attorney for the National Consumer Law Center.

“Currently, too many prepaid cards have substandard protections, limited functionality, and problematic fee structures,” Saunders told a Congressional subcommittee in March.

Even worse, some prepaid card issuers have been accused of keeping their fees secret. After receiving numerous complaints from Florida residents about prepaid issuers allegedly charging failing to disclose fees, Attorney General Bondi opened an investigation into five large prepaid card issuers: First Data Green Dot, Account Now, Netspend and Unirush.

“We will aggressively investigate these practices and ensure that Floridians are protected from hidden fees and charges,” Bondi said after issuing subpoenas to the five companies.

Prepaid cards are somewhat similar to secured cards, in that customers may only spend the amount they pay up-front. But secured cards are reported to the three national credit bureaus as lines of credit, which can help consumers improve their credit score, says Barry Paperno, a credit expert and Credit.com’s Community Director. Prepaid cards are never reported to the bureaus.

“Even though they have a Visa or Mastercard logo on there, prepaid cards are not on the credit report and therefore are not part of the credit score,” Paperno says.

So does a prepaid card make sense for you? It depends. If you already have a bank account, the answer is probably no, Detweiler says, since you can do all of the things with your bank account that you can with a prepaid card, only for less money.

“I have a hard time seeing a big market” for prepaid cards sold to people with bank accounts, Detweiler says.

If you don’t have a bank account, however, and you want to make online purchases or manage tight monthly finances, a prepaid card may be a good option. And just like with any financial decision, it’s important to do your homework beforehand, compare the fees charged by different prepaid cards, and “shop carefully,” Detweiler says.

Image: Cory Doctorow, via Flickr