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Prepaid debit cards may not be so bad after all

Prepaid debit cards -- criticized by many consumer groups for high hidden fees -- may actually be a cheaper option for some Americans, according to report released Wednesday from the Pew Charitable Trusts. 

“I was really surprised,” said Susan Weinstock, director of Pew’s Safe Checking Project. “I didn’t know that prepaid cards would be significantly cheaper for people who overdraft -- and they are.” 

Prepaid debit cards are convenient. You can buy them online or at the store, add money whenever you want, use them at most retailers and withdraw cash from any ATM. They’re like a bank debit card without a checking account attached, although some prepaid cards now offer savings accounts and online bill pay.

The market for these cards is growing rapidly. According to the Mercator Advisory Group, American consumers loaded $28.6 billion onto prepaid cards in 2009. That’s expected to top $200 billion by the end of next year. 

But are prepaid cards really a smart alternative to a checking account? According to the Pew report, for those who pay costly overdraft fees, the answer is a qualified yes. 

Pew researchers looked at 52 general purpose reloadable prepaid cards which represent about 75 percent of the market. Most are branded with the American Express, Discover, MasterCard or Visa logos, which means they can be used anywhere debit or credit cards with that logo are accepted. 

Sure, prepaid cards have a lot of service fees -- between seven and 15 different fees. The most common: card acquisition, monthly maintenance, ATM withdrawal, point-of-sale transactions and customer service calls. 

Most fees are less than $3. Even so, they can really add up. And some are significantly higher. The median monthly service fee for the cards in the study is $5.95; the median acquisition fee is $9.95. 

While prepaid cards might cost less than a checking account for some people, Pew says they come with significant risks:  

  • Comparison shopping can be a challenge: Checking accounts have a fairly uniform fee structure. Prepaid cards do not.  And there are no clear and uniform disclosure requirements. Pew says this makes it very difficult for people to find the best card for them.  
  • They’re not as safe as a checking account: “Checking accounts have protection against unauthorized use. So if somebody steals your bank debit card, you’re protected,” Weinstock pointed out. “If somebody steals your prepaid debit card, you don’t have any protection.”  Some prepaid debit cards promise to limit the loss from unauthorized use, but with a bank debit card your fraud protection is guaranteed by federal regulation.  
  • There’s no guarantee the money loaded onto that prepaid card is federally insured: Your checking account is insured for up to $250,000 by the Federal Deposit Insurance Corporation (FDIC).  Most of the companies that sell prepaid cards, such as Green Dot and NetSpend, are not banks, are not FDIC insured, so they have to take extra steps to make sure the money loaded onto their cards is federally insured. If one of these companies goes under and hasn’t done things properly, you could lose your money.  
  • Absence of federal oversight: No regulatory body currently monitors the prepaid card industry. The Pew study notes that this lack of oversight “could turn a potentially beneficial emerging product into a haven for predatory lenders and other unscrupulous actors.” The report calls on the Consumer Financial Protection Bureau (CFPB) to develop rules to prevent unfair, deceptive or abusive practices. The CFPB recently announced that it is considering whether to propose new rules for the companies that sell prepaid cards.  

Why do people buy these cards?

Pew conducted focus groups to find out why prepaid cards are so popular. 

In addition to avoiding bank overdraft penalty fees, some say it helps them stick to their budget because spending is limited to the amount loaded on the card. Indeed, Pew found that most prepaid cards do not permit an overdraft. But a small number do allow a customer to overdraw. The median fee for that is $15. 

Others feel prepaid cards provide more privacy and fraud protection than credit cards or bank debit cards. 

The bottom line

Prepaid debit cards can be a useful financial tool for some people, especially those who do not have or want a bank account. They can also be a way for parents to give their kids money without giving them cash or access to their bank account. 

But the Pew study concludes: if you have a checking account and you don’t pay overdraft penalty fees, that checking account is still probably your best deal.

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Herb Weisbaum is The ConsumerMan. Follow him on Facebook.

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Pew Quiz: Prepaid vs. Checking