Study: Prepaid cards full of hidden dangers

Consumers groups call them second-class payment citizens

By Cara Henis

Touted as a way to stay debt-free, prepaid card cards are increasingly being marketed to those leery of traditional credit and debit cards.

Yet, as with a rose, watch out for thorns. Prepaid cards -- reloadable cards on which consumers place money and then use like debit cards to make purchases -- are replete with their fair share of fees, according to an August 2009 report by attorney Michelle Jun of Consumers Union. The report was prepared on behalf of low-income clients of the Consumer Federation of America and the National Consumer Law Center.

Two major prepaid card concerns voiced by Jun are the extensive fees heaped upon unaware consumers and incomplete protection of money placed on the cards. Green Dot, one leader in the prepaid card industry, reported more than $4 billion in customer transactions on their cards in 2008 alone, meaning an increasing number of consumers need to make sure they understand what's in their wallet.

"The devil is in the details, and upon closer examination, these cards are laden with numerous types of fees and other gotchas, making prepaid cards a shaky alternative to a bank account with a debit card," Jun said in her report.

All prepaid cards carry a price tag for users, yet these costs aren't always visible until the cards are bought and unwrapped from their packaging. The type and extremity of such charges vary by card, and attention to the fine print is the only way to know whether to expect usage charges.

Fees can include:

• Activation fee.
• Monthly fee.
• Annual fee.
• Balance inquiry fee.
• ATM fee.
• Dormancy fee.
• Custmer service fee.
• Reloading fee.
• Bill payment fee.

Some cards also impose a fee on each purchase made, raising prices when a customer uses the card like a debit (entering a PIN number) than when a signature-based transaction takes place. Even access to a transaction statement, detailing a customer's purchase history, can cost money. Some cards charge up to $6 for a paper copy.

Out of the 24 cards examined, all charged for ATM use and for reloading the cards. Most cards also collected an activation fee, with costs ranging from $3 to $40. Monthly or annual fees are popular as well, with average monthly fees under $10. Some annual fees were as high as $100.

In addition, prepaid cards provide substandard protections and benefits, said Ed Mierzwinski, who serves as consumer program director of U.S. Public Interest Research Group, a public interest organization.

They represent "all the bad parts of the current system, with none of the benefits," Mierzwinski says.

Prepaid card funds not protected?
Consumer fund protection is one of the "bad parts" that Jun and Mierzwinski say has escaped thorough government attention. Prepaid cards aren't regulated by the federal Electronic Funds Transfer Act, which governs debit card transactions, or the Fair Credit Billing Act, which covers credit cards. Each protects consumers when their debit or credit cards are used fraudulently. Under EFT, a customer is partially shielded from fraudulent charges. Consumers also have the right to dispute charges that appear on their debit card. Credit card users are extended similar rights under FCBA.

With prepaid cards, however, the card issuer determines what, if any, protections are granted. Oftentimes, they are less comprehensive and subject to the whim of the company.

FDIC protection limited?
An identity crisis of sorts exists, too, between the cardholder and the issuer, as it isn't clear exactly who the money really belongs to once it's loaded onto a prepaid card. The Federal Deposit Insurance Corporation (FDIC), which guarantees bank deposits of up to $250,000, may not protect prepaid cardholders' deposits. The situation is sticky because consumers don't place money into a personal bank account; they deposit into a pooled account owned by the card company. The way the card issuer sets up the account determines whether each cardholder is protected up to $250,000 or whether only the pooled account is protected. If just the pooled account is protected, then each individual is not necessarily insured. Prepaid cards claiming FDIC membership may be referring to the pooled protection, which does not shield every customer from loss.  

"Consumers who use or are considering using prepaid cards do not have the same guarantee that they would recover all their money in the event of a bank failure," Jun said in her report. "A growing number of consumers are using and relying upon prepaid cards to manage household funds and conduct daily financial transactions, making consumer protections increasingly critical for prepaid cards."

See related: Prepaid card use rising as credit cards stutter, 9 ways to budget with a prepaid card, What happens to prepaid cards when a business is sold?

Published: August 26, 2009

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