4 Reasons a Prepaid Debit Card Can Cost You Big

  • Share
  • Read Later
Daniel Acker / Bloomberg / Getty Images

The Los Angeles Times recently reported that a TSA worker was caught after stealing valuables from passenger luggage. Among the pilfered items was a prepaid debit card with $1,000 loaded on it. While having a debit card stolen is always a nerve-wracking experience, the stakes are much higher with prepaid cards than with one linked to a checking account.  General purpose, reloadable prepaid cards that can be bought from major retailers are becoming an increasingly large part of the mainstream financial landscape. People use them in lieu of a checking account, load their kids’ allowances on them and give and receive them as gifts. But there are a few things consumers need to keep in mind when it comes to the risks of prepaid debit cards.

1. Lack of Liability Protection

Prepaid cards are exempt from mandatory protections under the law, meaning those funds aren’t as safe as we might think, says Suzanne Martindale, staff attorney at Consumers Union. “You don’t have a guaranteed set of laws and procedures that ensure you can get most if not all of your money back if something goes wrong.” While most major prepaid card issuers today voluntarily follow the laws in place for bank-issued cards, that’s wholly at their discretion. In other words, if the issuer of the card that was stolen by the TSA agent wanted to, it could refuse to restore those lost funds to the cardholder.

(MORE: Free Movie Tickets Used to Push Prepaid Plastic)

2. Too Many Fees

One big source of negative publicity for prepaid cards is the plethora of fees issuers levy for everything from customer service to reloading the card with money. Some even charge cardholders who want to close their account and have the remaining funds mailed back to them as a check. The website CardHub.com published a study of prepaid debit fees charged by the five biggest issuers, comparing how much a cardholder would have to spend to use the card either as a substitute checking account or as a tool for a child’s allowance. And there’s a pretty big discrepancy between issuers.

Odysseas Papadimitriou, founder and CEO of CardHub, says the sheer number of fees make it difficult for people to figure out how much using a prepaid card really costs them. “There’s all this fine print geared at hiding the true cost of using the product,” he says. “Even for us, it’s hard to evaluate 50 cards in depth, and we do this for a living.”

(MORE: Can You Buy Stuff Online Without a Credit Card?)

3. No Protection if Bank Goes Belly-Up

Yet another wrinkle is the fact that cardholders can almost never be sure their money will be protected if the bank holding their funds goes belly-up. If you have a checking or savings account at a bank that fails, the FDIC will step in and restore the funds up to $250,000 per account. But prepaid card issuers often bundle cardholder assets together in a single processing account that could contain millions of dollars, well above the FDIC’s limit. There is an accounting mechanism called “pass-through insurance;” essentially it means that the card issuer and the bank have to work together and keep straight whose money is whose. The trouble is, nobody knows if prepaid card companies do this, says Consumer Union’s Martindale.

4. Shady “Overdraft Coverage”

All this might be enough to give a consumer pause, but the final problem with these cards is the most alarming of all. Some cards now offer what they term “overdraft coverage” or an “advance on direct deposit.” Both are essentially payday loans that sock a cardholder with up to 300 percent interest and can create a downward spiral of escalating debt, says Lauren Saunders, managing attorney for the National Consumer Law Center. What’s more, these features take away the main selling point of prepaid cards: You can’t spend more than you have.

Since people don’t get a statement and don’t have a relationship with a traditional bank, they don’t think of these cards as being accounts, but they are, Saunders warns. “It’s really critical that you treat this as a real account, and when you’re done with it, close it. Don’t just throw the card away.”