Pros and cons of prepaid cards

By Liz Pulliam Weston

I admit it: I had thought prepaid cards were only for the financially challenged until the folks on the Your Money message board educated me otherwise.

Prepaid cards are reloadable spending cards. They often carry a Visa, MasterCard or Discover logo, and they're sold by Wal-Mart, H&R Block, Western Union and other outlets.

They're not debit cards or credit cards, or gift cards, but a different and increasingly popular way to pay without tapping a bank account or running up a credit balance. Once you buy one, you can continue adding money to the balance, and you can use it just about everywhere debit or credit cards are accepted.

Some people use prepaid cards because they can't get a bank account (they bounced too many checks) or because they can't handle credit cards. But not everyone fits that mold.

First, the positives

Posters on Your Money use prepaid cards:

To limit spending. Poster "momofg" said she took one on a Disney World vacation. "For me it was easier than taking all that cash," she wrote. "The convenience of a credit card without the possibility of overspending."

For peace of mind. Poster "ccplvnv" uses them for online purchases that might otherwise auto-renew, such as magazine subscriptions, while "BackInDC wants some sleep" used one for a while after a thief accessed a bank account. The card "eased my fears about my bank info having been compromised," BackInDC wrote, "because at least I had enough on that card to cover rent and bills if need be, until the mess was sorted out with my bank."

As an allowance. Some folks load a prepaid card with a weekly allowance for their kids or give them a prepaid card when it's time to go clothes shopping. Poster "lmw0507" gave a prepaid card to a daughter who traveled overseas this summer. "No one uses traveler's checks any more," lmw0507 wrote. "When she did need a bit more money, we were able to load it with cash online."

As gifts. Poster "ccplvnv" wrote, "My parents and in-laws hand them out at Christmas like candy. I in turn do the same for my kids. I used to give them cash, but they like to shop online."

For privacy. Poster "Herring" likes the anonymity. "You can buy things that can only (be) bought with a credit card, without giving any (actual) personal information," Herring wrote. "I prefer to have various details of my personal life omitted from private and government databases."

Out of the frying pan

For all the above reasons and more, demand for prepaid cards has exploded. The dollar volume of transactions grew from less than $1 billion in 2006 to more than $4 billion last year, according to Mercator Advisory Group, which predicts $7.2 billion in transactions this year.

You can use the cards for casual spending or have your entire paycheck regularly deposited to your card. In fact, some employers now issue prepaid cards in lieu of paychecks to workers who don't have bank accounts.

Video: Kids and debit cards

But prepaid cards have significant dangers and disadvantages. A sampling of the hazards:

The fees. There are fees to activate, reload, use and even shut down your card. In fact, there are so many fees, and they can be so cleverly hidden, that Consumer Reports staff attorney Michelle Jun called prepaid cards "a shaky alternative to a bank account with a debit card."

Jun detailed all the common fees in her report "Prepaid Cards: Second-Tier Bank Substitutes" (.pdf file), but here are just a few:

• Activation fees. Some cards don't have a fee, and some charge $30 to start, although the median fee to get and activate a card is $10.
• Reload fees. To put more money on the card, expect to pay $3 to $5. ("Reload packs" are available in many grocery and convenience stores.) Direct deposit of your paycheck is typically free.
• Monthly fees. Most cards charge $10 a month.
• Cash withdrawal fees. Users may pay $2 to get cash at an ATM (on top of the bank's ATM fee) or $4 to $5 to get cash from a bank teller.
• Declined-transaction fees. If you try to use a card for a purchase or withdrawal and don't have enough cash left on the card, you'll often pay a fee to be told the transaction has been declined. The fee can range from 15 cents to $2.95.
• Dormancy fees. If you don't use the card for two or three months, many of the issuers Jun studied start charging a $1.50 to $5.95 monthly dormancy fee.
• Closure fees. Getting any remaining cash out of your card once you're done using it could cost you $10 to $15.

Fees for making transactions, paying bills, talking to a customer-service rep or checking your balance are also common.

Continued: How safe are they?

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