Think Twice Before Using a Prepaid Card

ARLINGTON, Va. (TheStreet) -- Roughly 62% of prepaid cards lack the features necessary to meet the average consumer's needs, according to CardHub's latest Prepaid Report. That's right: Despite all the buzz surrounding this new-to-mainstream-use financial product, the odds are that a given prepaid card won't do much for you. Oh, and picking the wrong prepaid card can also cost you upward of $350 per year.

Wasting a bunch of money on a prepaid card that doesn't even bolster your financial management repertoire is a worst-case scenario. Unfortunately, it will inevitably become reality for a large segment of consumers given our overall lack of financial literacy and the marketing power behind some of the highest-profile offers.

That's not to say that all prepaid cards are bad, though. You can certainly find a prepaid card that saves you money and makes personal finance easier if you know what you're looking for (i.e., why you need or want a prepaid card) and are willing to read a bit of fine print.

The first step is understanding exactly what a prepaid card is as well as what it can offer.

Prepaid card overview

First of all, a prepaid card is not a credit card. It's important to say that right off the bat because most consumers search for "prepaid credit cards," borrowing a term crafted by industry players looking to deceive.

In the most basic sense, a prepaid card is a debit card without the accompanying checking account or physical checkbook. More specifically, it's a debit-based spending vehicle that enables you to load funds to an electronic account and then make purchases at the point of sale, cash withdrawals at ATMs, monthly bill payments, etc. You can load funds online, at a retail location, at an ATM or via direct deposit.

Consumers typically use prepaid cards in one of three ways:

  • Replacement checking account: Many prepaid cards offer the same utility as a traditional checking account/debit card, and many consumers prefer electronic payments to check writing anyway. A prepaid card at the right price can therefore serve as a viable alternative to a standard checking account, especially since banks have eliminated debit card rewards programs and/or instituted new fees/minimum balance requirements in the wake of the Durbin Amendment.
  • Alternative check cashing tool: It's no secret that check cashing stores are ridiculously expensive, charging 1% to 20% of a check's amount plus fixed fees just so you can access your own money. But unbanked consumers often feel as if they have no other options. Fortunately, a few of the newest prepaid cards allow users to cash checks directly into their accounts without incurring any fees.
  • Means of providing a child's allowance: Visa's Global Financial Literacy Barometer revealed that more than 70% of parents don't believe their children know the basics of responsible money management. Something clearly has to change if future generations are to avoid making the same financial mistakes as their predecessors, and a prepaid card can be quite useful to that end. Providing your child's allowance via prepaid card will give them experience paying with plastic, making ATM withdrawals, budgeting, etc. The fact that prepaid cards offer online account management will also give you the opportunity to review your child's spending habits and provide advice as needed.

Finding the right prepaid card

Prepaid cards clearly aren't created equal, as evidenced by their drastically varied annual costs and the fact that different offers provide different features. As such, anyone who thinks they're in the market for a prepaid card must tailor their search to their particular needs as well as consider alternative options before submitting an application.

With that said, here are some rules of thumb to live by when pursuing a prepaid card:

  • If you want a replacement checking account, consider only prepaid cards that offer free direct deposit, online bill pay and ATM withdrawals (at least at in-network ATMs).

  • If you want an alternative check cashing tool, make sure the prepaid cards that you consider offer the ability to load checks directly as well as free withdrawals at in-network ATMs.
  • If you're seeking a means to provide a child's allowance, focus on cards that offer free deposits from a bank account as well as free in-network ATM withdrawals.
  • Always consider how much a given prepaid card will cost you in practical terms. In other words, evaluate each card's costs in terms of your intended monthly use.
  • Before applying for a prepaid card, compare its total cost with alternatives such as a traditional checking account to ensure you're getting the best possible deal.

Final thoughts

At the end of the day, it's clear prepaid cards are a high-growth product that's here to stay. As issuing institutions and the regulatory environment mature around them, the distinctions between prepaid cards and checking accounts will become less pronounced. This will leave consumers with more viable options for everyday cash management, ultimately leading to increased savings and better customer service.

Odysseas Papadimitriou is CEO of the card comparison website CardHub as well as the new personal finance social network WalletHub.

Odysseas Papadimitriou is founder and CEO of Evolution Finance, the parent company for Wallet Blog and Card Hub.