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Prepaid cards a new way to bank?

Reloadable cards take off despite higher fees, fewer protections

By Michelle Crouch

You see them in almost every checkout line display, propped next to phone cards, iTunes cards and Olive Garden gift cards, emblazoned with the familiar Visa and MasterCard logos.  But the reloadable prepaid cards with names such as Green Dot and NetSpend are much more than just another option for gift-giving.  For a growing number of Americans, they're a new way to bank.

Prepaid cards a new way to bank?

The appeal of prepaid cards
Analysts say the prepaid cards are one of the consumer banking industry's hottest new products. In 2009, $124.6 billion was loaded onto all types of prepaid cards, up 61 percent from 2008, according to Mercator Advisory Group. Just for open-loop cards -- those that can be used anywhere -- it projects transactions will soar to $308 billion in 2012.

The cards, sold at retailers such as Walmart and Walgreens, look and act like bank debit cards. But instead of siphoning money from your bank account, you load them with money in advance, and you can add to the balance whenever you want. You can use them almost anywhere you use credit and debit cards, including at ATMs, without worrying about racking up debt or overdraft fees. 

Prepaid cards appeal to students who don't qualify for credit, consumers who want to limit their debt, and travelers who don't want to carry cash. They're used by parents to limit their kids' spending and by government agencies to pay out Social Security, unemployment and welfare benefits. But much of their explosive growth has come from consumers with no bank accounts -- in industry terms, the "unbanked."

"No matter what happens with the economy, some part of the prepaid market is going to grow," says Ben Jackson, a senior analyst with Mercator Advisory Group, a research group focused on the credit and payments industry. "In a good economy, people buy them for travel, they buy them for gifts, they use them to give money to their kids who are away at college. In bad times, the government puts more money on them for benefits, and they get a lot of business from people who lose their bank accounts."

Prepaid cards and the unbanked
About 9 million American households, or one in 13, don't have any bank account at all, according to the FDIC. The prepaid cards give them a place to have their paycheck direct deposited, a means to make purchases online and a way to put rental cars, airline tickets and hotel rooms on hold.

The cards were originally created as a vehicle for young people who couldn't get credit cards but wanted to shop online, says Mark Troughton, president of cards and networks for Green Dot, the largest player in the prepaid market. Card issuers soon realized they were a good fit for those without bank accounts and began marketing them that way. The global economic downturn, meanwhile, increased demand, as fewer people qualified for traditional credit cards and bank accounts, and consumers looked for ways to avoid debt.  A recent study by Javelin Strategy & Research shows that credit card use decreased 31 percent between 2007 and 2009.

A lot of those cautious consumers turned to prepaid cards as a tool for budgeting and careful spending. Half of Green Dot's 3 million active card users today have bank accounts, Troughton says. "We've found that the reality is that people who are using our products are everyday America:  the school teachers, the firemen, the nurses."

And the publicists. Cyrus Webb, who does publicity for authors and entertainers from Brandon, Miss., says he uses a prepaid card regularly even though he has a checking account. "I use it for paying bills online and for trips instead of travelers checks," he says. "I like that it doesn't have a lot of personal information attached to it, and it helps me keep my spending under control."

Are prepaid cards fee-laden?
Some consumer advocates are concerned about the trend, however. They say the cards can carry a wide array of hidden and unexpected fees: a $5 fee every time you put money on it, for example, or a $1 charge every time you use it. Some also carry fees for reloading, making cash withdrawals, checking the balance, for inactivity or for calling customer service. 

"We steer our clients away from these cards," says Bruce McClary, spokesman for ClearPoint Credit Counseling Solutions, a nonprofit consumer credit counseling service. "They don't come with high interest rates, but they often have fees buried in the contract. I don't think consumers really understand what they're getting into when they get these."

FEES TO ASK ABOUT BEFORE
BUYING A PREPAID CARD

Before you purchase a reloadable prepaid debit card, consider how you'll load it, what your balance will be and how frequently you'll use it. Then check the cardholder agreement for these types of fees, and decide which card best meets your needs:

  • Activation fee. A one-time charge that typically ranges from $3 to $29 and averages around $9.95.
  • Reload fee. You can often avoid this fee if you have your paycheck direct-deposited onto the card.
  • Monthly maintenance fee. A pretty standard fee that ranges from 99 cents to $10, but will sometimes be waived if you load a certain amount onto your card or make a specific number of transactions.
  • Cash withdrawal fee. As with debit cards, you'll typically pay a fee to use out-of-network ATMs, plus the ATM owner fee.
  • Over-limit fee. While these cards typically don't allow you to spend more than what's on them, if you use it as a credit card and sign for it, there can be a processing delay. Then you may still be able to make a payment that exceeds your limit, incurring a charge.
  • Dormancy fee. This is a fee you pay if you don't use your card for a certain amount of time.
  • Bill-pay fee. Is it free to pay bills online with the card?
  • Other types of fees. Dormancy fees, closure fees, balance inquiry fees, declined-transaction fees and customer service fees are all common. 

In a report released Sept. 15, 2010, Consumers Union, the nonprofit publisher of Consumer Reports, advises consumers to be wary of the cards. In addition to excessive fees, prepaid cards don't carry the same legal protections as traditional debit and credit cards, says report author Michelle Jun, a staff attorney for Consumers Union.

"Even if the card comes with the same terms and conditions you'd get with a regular credit card, they're not guaranteed under federal regulations or law, so you're at the mercy of the company," she says. "We've had some complaints from customers who had their cards stolen, documented everything, but they still get ignored or told there's some kind of loophole."

Customers also have no guarantee they'll be able to recover all their money in the event of a bank failure because the funds may not be insured by the FDIC, Jun says.

Consumers Union has asked the Federal Reserve Board to extend federal protections to prepaid cards.

Prepaid card issuers say their fees are lower than they used to be and note that most people with an annual household income under $75,000, their target demographic, would pay a lot more for check cashing (1 percent to 4 percent is common) or even a traditional bank account.

"Most of our customers who use our card regularly, use it for free with the exception of out-of-network ATMs and cash loads at retail stores, and there are ways to avoid those," says Troughton. "You'd be very hard pressed to find a major bank that has fees anywhere near our level without significant minimum balance or direct deposit requirements."

You just have to choose your card carefully, says Webb, echoing the experts: "My brother got one that charged 99 cents for every purchase and it really added up," he says. "You make five purchases a day, and that's $35 a week."

See related: Prepaid cards replace checks as rebate payment of choice, Prepaid card use rising as credit cards stutter, 9 ways to budget with a prepaid card, Prepaid cards full of hidden dangers, Proposed Treasury rules take hard line against prepaid card fraud

Published: September 16, 2010



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