Prepaid Debit Cards: Viable Alternative to Free Checking or Risky Business?

What you need to know about prepaid debit cardsNow that BB&T has become the latest major bank to announce the end of free checking, untold thousands of additional cash-strapped consumers are desperately trying to find a way to make ends meet without getting hit by usurious fees.

A trade group representing the prepaid debit card industry argues that the prepaid cards – which are preloaded with funds and used like normal debit cards – are the answer, although one national consumer advocate warns they're a poor substitute for standard bank accounts.A Tuesday announcement by the Network Branded Prepaid Card Association (NBPCA) says prepaid debit cards are tailor made for consumers looking to avoid rising bank fees. The group backed up its assertion by citing a study released last month that found consumers who use prepaid debit spend some as little as $76.35 a year in fees, compared to those with checking accounts, who pay $218 or more per year.

However, a new report issued a day earlier by Consumers Union, the nonprofit publisher of Consumer Reports, contradicts those findings, and says prepaid debit cards cost more to use than checking accounts.

"In an environment where free checking accounts are becoming a thing of the past, more consumers are joining the ranks of the unbanked and turning to prepaid debit cards as safe, secure and efficient tools to budget their money, control spending and avoid debt," Kirsten Trusko, president and executive director of the NBPCA, said in a statement.

"Because cardholders can only spend money pre-loaded to the cards, prepaid cards inherently teach money management skills, making them an ideal tool for parents to use in educating their children about financial responsibility," she added.

The group also spelled out a number of consumer tips for choosing a prepaid debit card, including the need to study all terms and conditions, compare fees among competing cards, make sure they protect users against fraud and are FDIC insured.

Meanwhile, it's no secret that banks are scrambling to make up for lost revenue in the wake of the Credit CARD Act, new overdraft rules and restrictions on debit card fees imposed by the Dodd-Frank financial overhaul bill, which the Wall Street Journal says could cost banks upwards of $9 billion a year. And unlike regular debit cards, prepaid debit cards aren't subject to any Dodd-Frank restrictions, which make them especially attractive to banks eager to boost their balance sheets.

But in an earlier report from September 2010, Consumers Union called prepaid cards "second-tier bank account substitutes" and listed the following shortcomings they suffer from compared to traditional debit cards:
  • Fees can be high, multiple and confusing.
  • Not all prepaid cards provide adequate protection against theft of funds using the cards or card account numbers.
  • Promised credit lines or features to build a credit record may be expensive and overstated.
  • Federal deposit account insurance applies differently and may be capped at less than the value of all of the prepaid cards issued by a particular card program.
Prepaid debit cards, the Consumers Union report also noted, typically carry all sorts of fees, including activation fees; monthly fees; point-of-sale transaction fees; cash withdrawal fees; balance inquiry fees; customer service fees; bill payment fees; balance adding fees; dormancy fees; overdraft fees; and fees to retrieve your remaining balance when closing your account.

"Until consumers who use prepaid cards are guaranteed the same protections as consumers who use traditional debit and credit cards, consumers who use prepaid cards will be at risk of losing all their money, face multiple, high, and sometimes confusing fees, and be offered convenient but very expensive forms of credit associated with the card," the report concluded.

If you do decide prepaid debit cards make sense for you, be wary of how they're marketed to you, since the FTC recently fined a pair of swindlers $800,000 for deceiving hundreds of thousands of payday loan applicants into ordering unwanted prepaid debit cards.

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