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Making sense of prepaid debit cards

January 24, 2012

| MoneyRates.com Senior Financial Analyst, CFA

Suze Orman is generally known for her sensible financial advice, so it was slightly strange to see her drawing heat for her recent venture into the prepaid debit card market. But since prepaid debit cards tend to be a lightning rod for criticism from consumer advocates, the controversy over the Approved Card by Suze Orman probably shouldn't have been a surprise.

But Suze's troubles aside, what's the truth about prepaid debit cards? Are they a useful tool or a rip-off?

Like most financial products, prepaid debit cards are neither good nor bad by nature. It's the specific terms of each product that determines whether it's worthwhile. Understanding what prepaid debit cards can do for you, and how to control their costs, will help you use them to your advantage.

When a prepaid debit card might make sense

A prepaid debit card might make sense if you:

  1. Need to enforce a budget limit. If you have a history of running up large credit card bills or incurring frequent overdraft fees, a prepaid debit card will help by keeping you on a pay-as-you go basis.
  2. Can't qualify for a free checking account. Fees on checking accounts are often higher than prepaid debit card fees, so if you can't get a free checking account, a prepaid debit card may be a cheaper way to handle your money.
  3. Want an alternative to cash. If you don't feel secure carrying cash in your wallet, a prepaid debit card could help ease those worries. Or, if you run a business, you may find a prepaid debit card is more efficient than keeping petty cash on hand.

Clearly, prepaid debit cards have legitimate uses. The key question is whether these uses are worth the cost.

What to look for in prepaid debit cards

The tough thing about prepaid debit cards is not simply that the fees can be exorbitant, but that the fees come in so many forms. The following are just some of the fees you might find on a prepaid debit card:

  • Upfront purchase fee
  • Monthly fees
  • Transaction fees on purchases
  • ATM fees
  • Reloading fees

So what's a reasonable amount to pay for a prepaid debit card? At the most outrageous end of the spectrum, the notorious Kardashian Kard cost nearly $60 upfront and then $100 a year to use. Fortunately, the sisters dropped the card about as quickly as Kim dropped her husband.

By comparison, Suze Orman's Approved Card seems much more reasonable, with just a $3 upfront fee and a $3 monthly fee. However, there is no reason to pay even those costs. American Express offers a prepaid debit card with no upfront or monthly fees. The Visa Upside card also has no upfront fees, and can cost as little as $0.99 a month if you load $500 a month onto it.

Here's a rule of thumb: Celebrities typically get paid for their endorsements, and that expense is likely to add to the fees that a card charges. You don't need anybody's name on the card except your own, so it will probably be cheaper if you avoid a celebrity-endorsed card.

Finally, keep in mind that prepaid debit cards have blossomed in popularity during a time of extremely low interest rates. In a more normal interest rate environment, missing the opportunity to earn interest on your money rather than paying it to a card company upfront would be a bigger sacrifice, and this would effectively add to the cost of using a prepaid debit card.

The truth about credit scores

Finally, any examination of prepaid debit cards should include a discussion of their relationship to credit scores.

Since prepaid debit cards are a viable option for people who can't qualify for credit cards, they are often marketed as being a benefit to people with poor credit scores. However, this is sometimes stretched to include a suggestion that the cards can help you rebuild your credit rating -- but there is no evidence to support this yet.

Orman touts the fact that TransUnion, a major credit bureau, has agreed to study usage data on her Approved Card. However, this is a far cry from factoring that data into anyone's credit score, and it seems unlikely that a prepaid card could ever have much bearing on a person's credit history since it doesn't involve borrowing money.

In short, you may find a prepaid debit card to be a useful tool, but you should understand its limitations -- and the ways to limit its costs.

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