The Rise of Prepaid Credit Cards

Tight credit means prepaid cards are growing in popularity -- but watch out for fees.

By + More

Today's guest blog entry comes from Jeremy Simon, a reporter with CreditCards.com who writes about payment-card-related topics for consumers. He also contributes to Taking Charge, the website's blog.

As the recession encourages less reliance on credit cards by both consumers and banks, some experts predict that prepaid and secured cards could see their popularity grow.

Prepaid and secured cards are typically marketed to consumers who don't have enough credit history to qualify for a regular credit card. However, the current economic troubles mean an increasing number of consumers may find that credit cards have moved beyond their reach. According to Judith Rinearson, a stored value expert and partner with the law firm Bryan Cave, tightening credit could encourage a move toward prepaid and secured products. "I think there will be an increase of interest in these cards," she says.

Unlike debit cards, which require a checking account, both prepaid and secured cards do not typically need to be tied to a consumer's bank account. Network-branded prepaid and secured cards bearing the American Express, Visa or MasterCard logo can be used anywhere that plastic payments are accepted.

Prepaid cards (similar to the popular retailer-issued store gift cards) are loaded with money and therefore do not require the cardholder to pay any bills. Meanwhile, secured cards require the borrower to first deposit money into an account held by the card issuer, who then provides a credit card with a spending limit equal to that deposit. That protects the lender in case of default. "A secured credit card is still technically a credit card," Rinearson says, with the cardholder receiving a regular bill as they would with a more traditional credit card.

For consumers interested in a prepaid or secured card, there are a few things to consider:

  • Know your fees. Since many types of payment cards have added costs, "You should always know what the fees are," Rinearson says. These expenses could include annual or monthly service fees, ATM withdrawal fees and even purchase transaction fees when the card is used to buy something.
    • Protect yourself. The biggest difference between credit cards and prepaid cards lies in the ability to dispute charges. "There are different consumer protection laws for credit, debit and prepaid" cards, Rinearson says, with all branded cards afforded varying degrees of rights when it comes to unauthorized purchases or unauthorized charges. While a consumer can refuse to pay for defective merchandise when their credit card bill arrives, it's often too late to avoid paying for a lousy product he or she actually bought using a prepaid card. "The merchant has already been paid," says Rinearson.
      • Build a credit history. Consistent, on-time credit card payments can help the borrower build a favorable credit history. That varies with secured and prepaid cards. According to Rinearson, "Secured credit cards are generally reportable to the credit reporting agencies and prepaid are generally not reportable. Of course, there are exceptions to every rule," she says. That means applicants looking to improve their credit score should consider a secured card that reports to the credit bureaus. Ask the card issuer whether it reports to the credit bureaus before applying; confirm it afterward by pulling your credit report from www.annualcreditreport.com.
      • In addition to prepaid and secured cards, Rinearson also highlights the possible introduction this year of a new type of short-term credit card that would enable banks to review and re-price based terms annually based on the cardholder's payment behavior. Apparently, discussion about these short-term credit cards is taking place behind the scenes, with Rinearson hearing them discussed during a conference call with prepaid card lawyers.