The Pitfalls Of Prepaid Credit Cards

In theory, it's a sensible idea for someone who can't qualify for a credit card, and who is trying to rebuild their credit. But many consumers who receive prepaid credit cards find the theory simply doesn't hold up in practice.

A prepaid credit card looks like and works just like a regular credit or debt card, but there is one very big difference. Instead of borrowing the money from the credit card company when you make a purchase, you are actually using your own money.

When a consumer obtains a prepaid card, they send the company the amount they want the card to be worth. For example, if you send in $500, your credit card has $500 worth of purchasing power. At least, theoretically.

With a regular credit card, you are using the bank's money. The bank covers your purchase and sends you a monthly bill for all your purchases. You either pay it off, in which case there is no interest. If you pay on time, there is no fee.

Reasonable terms?

Since you are using your own money on a prepaid card, it stands to reason that the terms would be at least as favorable as a regular credit card, if not more so. But it doesn't work out that way.

Let's return to the example of the consumer who sent $500 for a prepaid card. In fact, they have less than $500 to spend because the credit card company immediately starts collecting fees.

Bevon, of Miramar, Fla., activated her AccountNow prepaid card in June and added $75 to it.

"I first used it at a Citgo gas station to purchase $10 in gasoline," she told ConsumerAffairs.com. "I then proceeded to use it at a department store but unsuccessfully. I then called the customer service department only to find out that they took $9.95 for maintenance fee and I won't be able to use the card until the gas station transaction is cleared."

Mounting fees

Despite the fact that it was Bevon's own money, the bank froze the amount on her card until the $10 gas charge cleared. By then, the fees were adding up.

"My Balance is now $39.00 and I have only used it for a $10 transaction," she said.

One nice feature about a prepaid credit card is you can't spend more than the money on your card. If the purchase will put you over the limit, your card will be declined at the point of sale. But that doesn't mean that you can't end up owing the bank money, something that should be theoretically impossible with a prepaid card.

"I got a First National Bank of Marin secured credit card about nine years ago," Jason, of Wichita, Kan., told ConsumerAffairs.com. "I put $50 on it and spent $21 before calling them and telling them to cancel it. The next thing I know I get a bill for $379.49."

After paying it, Jason through he was finished with FNBM. But he was wrong.

"Two years later I'm getting a bill for $573," he said. "I called them and they said since I didn't cut up the card and send it to them I was still being charged."

Ways to save on fees

In spite of all the fee-laden cards, a careful, savvy consumer can actually find prepaid cards with more reasonable fees. There are ways to save on fees too. Avoiding ATMs and selecting the "credit" option instead of the "debit" option when making a purchase saves money.

For that reason, and perhaps because of rising anger at big banks, a recent Mintel business survey found that 25 percent of households earning more than $100K per year -- the more profitable and desirable customers for banks -- agreed that they would be interested in using prepaid cards. Their main motivation is to avoid overdraft and/or other types of banking fees.

It's hard not to believe that prepaid credit card issuers sock users with huge fees because, up until now, most of the users have been those with little credit and few financial options. They charge them big fees because they can.

If more financially savvy consumers begin increasing their use of prepaid cards, figuring out ways to avoid the fees, it will be interesting to see if prepaid credit card companies find new ways to levy big fees.