But switching your spending to a prepaid card should not be done without careful consideration, or else you could end up paying a steep price for what you expected to be a simple convenience. That's because prepaid cards are largely unregulated: Issuers aren't hindered by the consumer protection laws that limit credit card fees. And that makes virtually everything fair game for additional charges: monthly maintenance fees, fees to reload, fees to extract cash, and even fees for calling customer service.
All that said, there are certain circumstances when prepaid cards are worth using. It all depends on who is using them, when, and why. Here's how to see if they make sense for you.
Reining in the Overspenders
Have a history of exceeding your credit limit and drowning in outstanding balances due? For those with credit difficulties, a prepaid card offers a built-in safety net against overspending since the credit limit of the card is based on the actual cash loaded on it. Prepaid cards' requirements to budget and monitor spending can prevent you from careening down the slippery slope of minimum payments and high-interest-rate accumulation into fiscal disaster. Customers can set up payments for recurring bills on a prepaid card, and separate those from discretionary spending to get a truer sense of their finances. In this case, a lower-fee card like Chase Liquid (JPM) or American Express Bluebird (AXP) might cost as much as the higher interest rate typically incurred by risky credit customers.
Serving the Underserved and Unbanked
Traditionally a product for the underserved banking customer, prepaid cards can provide similar services to a checking account or a credit card for those who have neither. Prepaid cards are issued for everything from tax refunds to unemployment checks and behave just like a credit card. When given the option of receiving funds on a prepaid card versus a check, individuals should weigh the costs and fees of the card against the occasionally longer processing time of a paper check.
Going on the Road
It used to be that travelers worried about carrying large amounts of cash on a trip would buy travelers' checks, a concept that seems charmingly antiquated now. Preloaded credit cards can help keep your vacation budget on track, and many offer some of the same benefits (purchase protection, roadside assistance) as credit cards. Also, if a prepaid card gets swiped in Bali, there's no need to make a panicked call back to the States, wondering if a scammer has been wiping out your bank account or running up your bills: The damage is automatically limited.
Rather than adding a teen or college student onto an existing credit card account, parents can get a prepaid card with online tracking and debt management tools. They're a great way to allot funds for books, send money for a trip home, or deposit a reward for good grades. While using a prepaid card won't help your kids establish credit, it will help them establish healthy financial patterns, as well as giving them a chance to prove their financial responsibility to you before they take the next step to a real credit card.
Your Backup Credit Quarterback
Many people have one primary credit card they use most of the time, and a secondary one they save for emergencies. But a credit card account that is largely ignored and unmonitored is a perfect candidate for identity theft. To be rid of that risk, load a prepaid card with a fixed amount (be sure you've picked one with no monthly maintenance fee or lapsed activity fee), and tuck it into the back of your wallet.
Warning: They Don't Help You Build a Credit Rating
While prepaid cards can be attractive for a variety of reasons, they're not an appropriate product for people who want to shore up bad credit. Despite what some deceptive ads suggest, prepaid credit cards have no bearing on a person's credit report and cannot directly help you rebuild your credit reputation.
Those who want to improve their credit scores but can't get a traditional credit card would be better served by a secured credit card, which requires a cash deposit held in a savings account as insurance against future incurred debt. The Wells Fargo Secured card, (WFC) for example, is secured against a customer account typically ranging from $3,000 to $10,000. With an annual fee of $25 and an APR of 18.99 percent, it's not an attractive deal for anyone with healthy credit. But prudent use of a secured card will help those with damaged credit rebuild their financial profiles.
Finally, regardless of why you're getting a prepaid card, pay careful attention to the fees associated with it. And if the prepaid relationship turns sour, turn back to other payment options, including that old standby: cash.
Molly McCluskey doesn't own shares of any of the companies mentioned. Join her personal finance and travel discussions on Twitter at @MollyEMcCluskey. The Motley Fool recommends American Express and Wells Fargo. The Motley Fool owns shares of JPMorgan Chase & Co. and Wells Fargo.