The uproar over bank fees has led some consumers to switch from traditional bank products to alternatives such as prepaid debit cards for online and retail transactions.
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Several prepaid debit card companies are enticing customers by offering a high-interest savings account to consumers who use their reloadable prepaid cards. Interest rates on savings accounts s high as 5.1%, 5.65% and 6% annual percentage yields are definitely eye-catching, particularly when traditional savings rates are often less than 1% APY.
Still, the savings accounts and prepaid cards have myriad restrictions, limitations and fees that could potentially reduce the impact of interest earnings. What are the pros and cons of these combinations for consumers?
"If you have a lot of money, a traditional bank (product) may be a good option," says Terry Maher, general counsel for the Network Branded Prepaid Card Association in Omaha, Neb. "But for Gen. Y kids or those who are underserved by banks, a prepaid debit card with a savings account can be a good option."
Typically, a savings account tied to a prepaid card will require a minimum deposit of $100 or less, but it often requires a direct deposit into the account of at least $500 per month to earn interest. The interest is paid on a maximum balance of $1,000 to $5,000, depending on the card.
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Maher says paying monthly fees on a checking account with a low balance, using a check-cashing service or taking out money orders are alternatives that can all be more costly than a prepaid card.
Michelle Jun, senior attorney with the Consumers Union in San Francisco, has compared the cost of a prepaid debit card with the cost of a checking account. She found that most prepaid cards carry higher fees than a basic checking account from one of the five largest banks in the U.S. She prefers to tie a savings account to a prepaid debit card.
"It encourages consumers to store some savings rather than turn to a short-term loan," Jun says. "On the other hand, consumers will have to do lots of homework to compare the fees they will be charged with their usage pattern. The fees could quickly eat into any of the interest earned on the savings."
Jun says that while prepaid cards can function as a good budget tool, consumers need to be aware that some of these cards lack Federal Deposit Insurance Corp. protection to cover losses, and most are limited in their protection against fraud or loss or theft.
"Consumers should read the contract to see what their protection is if they lose their card or if someone makes unauthorized charges with their card," Jun says. "And just because the website has the FDIC symbol doesn't mean that each individual customer is fully FDIC-insured to the maximum level. It could just mean the managers are covered by FDIC insurance, depending on how the accounts are set up."
If you have a prepaid debit card tied to money in a savings account and you are not adequately protected with limited liability for fraudulent use or with FDIC insurance, you could lose the cash in your savings account if the issuer goes out of business.
Kimberly Foss, a Certified Financial Planner and president of Empyrion Wealth Management in Roseville, Calif., says consumers need to be aware of the fees charged on prepaid cards as well as the limitations of the savings accounts tied to the cards.
"The interest rate on some of these cards is capped to a certain amount of savings, but some cards don't tell you what the cap is," Foss says. "Others pay the higher interest rate only on the first $5,000 and then pay just 0.1% on the rest."
Most prepaid debit cards require a direct deposit, sometimes with a specific minimum amount, to open a savings account or to earn interest. Access to the savings account is limited to six withdrawals per month.
In addition to reading the fine print on the savings account terms, Jun recommends checking for several possible prepaid debit card fees.
"Most prepaid debit cards have a purchase or activation fee and then a monthly maintenance fee, which is sometimes waived if you have a monthly direct deposit to reload the card," Jun says. "Then, depending on the plan, you could have a fee for every transaction, including checking your balance and withdrawing funds at an ATM. Some offer bill payment with the debit card account, but sometimes they will charge for that, too."
Some consumers are charged a fee to add funds to the account. Prepaid card issuers generally have a fee schedule on their websites that explains how customers can avoid some of the fees.
"If you are charged $1 or $2 for using the card with or without a PIN number or you are paying $5.95 per month, it may not seem like much. But, that adds up quickly and cuts into the interest you are earning on your savings," Foss says.
"The truth is a lot of people who choose to use prepaid debit cards couldn't control their finances, so they are using these cards to prevent themselves from overspending," she adds. "People who have trouble controlling their use of money are not likely to take the time to read the fine print to figure out how they can reduce the fees that they are being charged."
Maher says light users of a prepaid debit card can opt for a pay-as-you-go plan, while heavier users may want to pay a monthly fee.
"In some cases, the only fee will be if you go to a retailer with cash to load the card," Maher says. "So someone in a job with a lot of cash from tips may not want to use a prepaid debit card. You can find a way to pay low fees as long as you clearly understand what the costs are."
Many consumers who lack a bank account or a credit card are interested in establishing or improving their credit profile, but Jun says use of a prepaid card will not show up on your credit report.
"Prepaid debit cards are not intended to do anything to improve your credit," says Maher. "Prepaid debit card issuers are actively looking into a way to help people build credit through the use of these cards, but it hasn't happened yet."
Maher says savings accounts tied to prepaid cards can be a great option for consumers who have a low income or are just starting out and need to establish a small nest egg.
"They are not designed for people who have $25,000 or $30,000 in the bank," Maher says.