Prepaid Debit Cards Are Popular but Still Have Downsides

Walk into a convenience store like 7-Eleven or CVS Pharmacy and you're likely to see a few prepaid debit cards hanging on a rack.

And these payment cards, used for budgeting or as checking account substitutes, are getting more popular. Purchases on cards from the largest prepaid issuers increased 15.7% in 2014 compared with the previous year, according to The Nilson Report, which analyzes payment industry data.

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Despite their popularity, prepaid debit cards have their share of problems. In the last year both the RushCard and Walmart MoneyCard experienced technical glitches that resulted in cardholders getting locked out of their accounts for as long as a week. During that time, any money on these cards, including income that had been directly deposited onto them, was unavailable. But even outside of drastic events, prepaid debit cards have several downsides.

Frequent fees

Prepaid debit cards tend to charge fees for features you take for granted with a checking account, such as free ATM use, customer support, and online and mobile services. And unlike checking accounts, prepaid cards often don't offer ways to waive their monthly fees.

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Janice Elliot-Howard, an author in Atlanta, originally got a prepaid card that charged her a small fee every time she bought something. When she realized how much that was costing, she quickly canceled it and bought one that doesn’t have purchase transaction fees.

She isn’t able to avoid all fees, though.

“The drawback is the ATM surcharge [for cash withdrawals], but I do that very rarely,” she says.

One saving grace for many prepaid debit cards is that they don't allow overdrafts or have overdraft-related fees. With a checking account, you can get hit with an overdraft fee of around $30 or $35 for spending more money than you have in your account. But a prepaid card's frequent fees for transactions or ATM withdrawals can still add up.

Card details aren’t always clear

Elizabeth Avery bought a prepaid debit card at a drugstore for an upcoming trip overseas but later realized that the card couldn’t be used abroad.

"I find that the fine print is where I’m seeing the issues,” says Avery, founder of travel website Solo Trekker 4 U and a private equity investment banker in Washington, D.C. She had planned to use the card at international ATMs to get cash and had found no mention on the outside packaging that it was only for domestic use.

And that’s not the only information that can be missing.

"The disclosure for prepaid cards that are sold in retail don’t require that all the fees need to be mentioned on the outside packaging,” says Thaddeus King, who works for the consumer banking project at The Pew Charitable Trusts in Washington, D.C.

Protections still lacking

Prepaid debit cards, like credit and debit cards, belong to payment networks like Visa or MasterCard. As a result, you have fraud protections for card purchases but not the broader protections you get with a bank account.

“When it comes to bill pay or ATM transactions, those are not done on the Visa or MasterCard networks,” King says.

Other payment networks have similar exclusions. For those transactions, King adds, you have to rely on a card’s disclosures, which may not include protections apart from those on purchases.

Prepaid debit cards also aren’t required to be insured by the Federal Deposit Insurance Corp., or FDIC, which is how customers can recover their money if their bank or card issuer fails. Although many prepaid issuers offer coverage voluntarily, their cardholder agreements may say that the terms are subject to change at any time.

Checking accounts, in contrast, must have more fraud coverage because of a federal law that covers electronic and ATM transactions. They also have to be insured by the FDIC.

Good news for prepaid debit card holders may be in the works. The Consumer Financial Protection Bureau plans to propose rules later this year that would extend fraud protections for these cards to match those that cover checking accounts and debit cards.