Americans are more conscious of debt than ever. Feeling burned by bank overdraft fees of $30 or more, or by credit-card interest rates that can top 25 percent, a growing number of consumers are turning to prepaid, reloadable “cash cards.”
For a large segment of users, primarily low- and moderate-income consumers, these cards function as ersatz bank accounts. These consumers are referred to as the “unbanked” in card-industry parlance. With a cash card, those with poor credit or too little money to meet banks’ minimum account balance requirements can participate in the retail transactions most people take for granted: ordering goods online, paying for items with a quick swipe, getting cash on demand from ATMs.
These cards have confidence-boosting names like “READYdebit” and “UPside.” They feature the logo of Visa, Mastercard or Discover and are issued by companies like Green Dot Corporation and NetSpend. These cards are sold at retail locations as well as check-cashing storefronts and money-wiring outlets.
It’s a fast-growing niche; in 2007, $2.1 billion was placed on reloadable prepaid cards, according to Mercator Advisory Group, a market research company that specializes in the payment industry. By 2011, Mercator predicts that number will jump to $14 billion. Green Dot Corporation, one of the big players in the field, says they’ve seen a whopping 50 percent year over year growth rate in terms of dollars loaded onto their cards.
For those who lack the discipline or the know-how to manage their money, these cards can be a lifesaver in that they don’t let a user spend more than he or she has. It’s impossible to overdraw and accrue fines, or tap into a line of credit that could spiral into a nightmare of debt. But while these cards may be beneficial for consumers who want to avoid the temptation of spending beyond their means, they are no panacea. Reloadable prepaid cards have several key differences of which users might not be aware.
First, they’re expensive to use. “The basic situation with prepaid debit cards is that they tend to come with a multiplicity of fees, which make them relatively expensive to use,” said Jean Ann Fox, director of financial services for the Consumer Federation of America. With the exception of Wal-Mart’s $3 Moneycard, most cost $9 or $10 to acquire, and most charge maintenance fees of up to $10 per month after that. Since issuers like to advertise the fact that they don’t charge overdraft fees, it could be easy for a consumer to overlook the fact that everything from withdrawing cash at an ATM to calling customer service costs a couple of bucks. Adding more money to a card can also cost $5 or so if the transaction takes place at a retailer or Western Union location; the place doing the reloading takes a cut, too. Some issuers waive the reload fee if a user has their employer direct-deposit their earnings onto the card.
Want to cancel a prepaid card? Even that could cost $15 in fees. If a user has less than that left on a card, the cardholder can either spend what’s left without going over the amount, which would cause the card to be declined, reload it — for a fee— or just abandon the balance. As a rule, most card companies don’t charge for online account activity, but that might not be a viable option for lower-income unbanked consumers.
The unbanked also might not have the financial wherewithal or feel empowered enough to ask some hard questions about the security of their money after they make a deposit on the card, a prospect that worries consumer advocates and watchdog groups. “It’s an important question given the dollar volume flowing into these cards,” said Sarah Jane Hughes, a commercial law professor at Indiana University. “Whether or not there really is something standing behind those cards is very important.”
Americans with money in ordinary bank accounts are protected by the Federal Deposit Insurance Corporation. If the bank goes bankrupt, the government makes good on depositors’ money up to $250,000. Prepaid card users don’t necessarily have that assurance. It’s common for cash card issuers to pool all their customers’ funds into one account, which could easily go over the $250,000 maximum. What’s more, this kind of set-up would make the card issuer rather than their consumers the FDIC beneficiary if the bank failed.
At the request of advocacy group Consumers Union, the FDIC recently clarified that a provision called pass-through insurance would come into play with regard to prepaid cards. Essentially, this means that the cardholder rather than the card company would get paid. However, the FDIC also spelled out a series of steps card issuers have to take for pass-through insurance to be initiated — and there’s no law that says the card companies have to take those steps. According to Gail Hillebrand, senior attorney at Consumers Union, it’s up to issuers to do the right thing when it comes to protecting their users’ cash.
“The great victory is that these funds can be FDIC insured to the individual,” said Michelle Jun, staff attorney at Consumers Union. “The problem now is it’s unclear if all these cards are set up in this fashion, and it’s not entirely clear which ones are FDIC insured.” In other words, it’s buyer beware.
Lastly, although these cards carry the logo of brands like Visa, Mastercard or Discover, they are not credit cards. While this distinction may help users from getting — or staying — in debt, it also means that no matter how judiciously they use their card or manage their money, these efforts won’t go towards raising their credit score. In a marketplace where lenders are demanding high credit ratings, not building a positive credit history can be a real handicap. Relying exclusively on prepaid cards means the unbanked will have a tougher time breaking out of that categorization. As much as Americans want temptation-busting tools that protect them from the lure of expensive play-now-pay-later loans, opting out of the system via prepaid spending devices carries some hefty costs of its own.
Martha C. White is a freelance journalist in New York. She frequently writes on economics.