Prepaid debit cards are becoming more popular as a payment method. More than 23 million people use them regularly (source). For many, they offer a simple money management system. For others, they’re an alternative to other payment methods they either can’t or don’t want to have.
In this article, we’ll explore how prepaid debit cards work, who they’re designed for, and some pros and cons.
How prepaid debit cards work
A prepaid debit card functions similarly to a regular debit card. There is, however, one main difference.
“Prepaid debit cards do not draw funds from a checking or savings account managed by the card issuer,” says Bruce McClary, vice president of communications for the National Foundation for Credit Counseling.
When you open a prepaid debit card, you’ll create a transaction account with the bank that issues the card. You can only use the account to reload money onto your prepaid card and to transfer money out of the account to a checking account you specify.
Where you can use it
You can then use the prepaid card wherever its payment network – Visa, Mastercard, American Express®, or Discover – is accepted. You can also use prepaid debit cards to shop online or withdraw money from an ATM.
How to reload
Depending on the card, you’ll have different reloading options. Here are some options you may find as you’re comparing cards:
- Online transfer from a checking account
- Direct deposit
- Mobile check deposit
- ATM check deposit
- Cash reloads at a participating retailer
What fees to expect
Each prepaid debit card has its own fee schedule, and some are more costly than others. Here are some fees you may come across:
- Activation fee when you first open the account
- Monthly maintenance fee – this can sometimes be waived with direct deposit
- Cash reload fee at participating retailers
- ATM fee
- Purchase fee
Rewards are largely non-existent when it comes to prepaid cards. Some, however, do offer a small percent back on purchases to encourage you to use the card regularly. Just keep in mind that prepaid debit cards offering rewards may come with more fees than non-rewards cards.
As of June 2017, prepaid debit cards do not have the same fraud protections as debit or credit cards. However, the Consumer Financial Protection Bureau (CFPB) issued a final rule in October 2016 that requires prepaid debit card issuers to provide the same fraud liability protection as with debit cards. The rule goes into effect beginning October 2017.
Some prepaid debit cards don’t have FDIC insurance, which means that, if the card issuer goes belly up, you lose your money. Double check before applying to make sure you’re covered.
Who are prepaid debit cards good for?
Because prepaid debit cards are an alternative payment method to credit and debit cards, they’re best suited for people who either can’t qualify for one of those or don’t want one.
The Federal Deposit Insurance Corporation (FDIC) estimates that 9 million households do not have bank accounts, as of 2015.
For many, that’s because they have bad credit with ChexSystems, a credit reporting agency for bank accounts. This can happen if you’ve mishandled bank accounts in the past. For example, not paying overdraft fees or opening multiple bank accounts in a short period of time.
People who just moved to the U.S. may also have a hard time getting a checking account. Banks usually require a Social Security Number, which new immigrants may not have yet. A prepaid debit card is a good solution for them.
Parents with kids who are in school are also good candidates for a prepaid debit card. It allows them to load money onto the card for their kids to use, but doesn’t allow them to overspend like you can with a credit card.
Prepaid debit cards vs. credit cards: Pros and cons
If you’re interested in a prepaid debit card, know both its benefits and drawbacks before applying.
Compare the pros and cons to make a better decision.
- No credit check
- Good for budgeting
- Good to help kids learn to manage money
- Easy to reload
- Doesn’t build credit
- Limited fraud protection
- Few extra perks
No credit check: If you can’t qualify for a credit card because of your credit or you have a bad ChexSystems report, you’ll still be able to get a prepaid card.
Good for budgeting: “A prepaid debit card could be most helpful for someone who is looking for an effective way to control their spending and avoid going into debt,” says McClary.
Prepaid debit cards can help you set a budget and stick to it. Want to spend only $250 on groceries this month? Just add $250 to the card and, when it’s gone, it’s gone. With a prepaid card, there’s no chance of overspending like with a credit card.
Good to help kids learn to manage money: Regardless of how old your kids are, a prepaid debit card is a great way to help them learn how to manage money. You can add their allowance money onto the card and help them learn how to keep track of their balance and transactions.
Easy to reload: If you run out of money, there are plenty of options to add more.
Fees: Some prepaid debit cards are largely fee-free, but there are many out there that charge a plethora of fees for simple things like activating your card or using it to make purchases.
Many credit cards charge fees, but there are plenty of ways to skirt around them by simply not using those services (i.e., cash advances, balance transfers, etc.).
Doesn’t build credit: “Prepaid debit cards cannot be used to establish a credit history,” says McClary. “They don’t require repayment and would not report activity to the major credit reporting agencies.” If you’re looking to build or rebuild credit, consider a secured credit card instead.
No fraud protection: Until October 2017, you’ll be liable for any fraudulent purchases that happen with your card. Even when the CFPB final rule goes into effect, however, your protection will be on par with debit cards.
Few extra perks: Credit cards typically offer extra perks that you won’t get with a prepaid debit card. For example:
- Purchase protection in case an item you purchase with the card is stolen or damaged.
- Price protection, which refunds you the difference on an item you purchased if the price dropped shortly after you bought it.
- Extended warranty protection, which automatically extends the warranty on any item you purchase that has one.
Should you apply for a prepaid debit card or a credit card?
A prepaid debit card is perfect for people who can’t qualify for a credit or regular debit card. It’s also a great idea for someone who has trouble with overspending and wants to stay within a budget.
Plus, if you have kids, a prepaid debit card can help you teach them to use money wisely as you pay them an allowance.
If you’re in any of these camps, be sure to compare prepaid debit cards before choosing one. Consider features like fees, reloading options, FDIC insurance, and rewards as you research the options.
If you’re looking to build credit and/or you don’t have issues with overspending, you’d be better off comparing credit cards. Just keep in mind that the best way to use a credit card is to stick to a budget and pay off your balance in full each month. This way, you can build credit without needing to pay interest along the way.
Ben Luthi is a personal finance writer and a credit cards expert who loves helping consumers and business owners make better financial decisions. His work has been featured in Time, MarketWatch, Yahoo! Finance, U.S. News & World Report, CNBC, Success Magazine, USA Today, The Huffington Post and many more.