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The 411 on Prepaid Cards They may help control spending, but there are better ways to budget

prepaid cards

The 411 on Prepaid Cards They may help control spending, but there are better ways to budget

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What do the Kardashians, Magic Johnson, Justin Bieber and Lil Wayne all have in common? (And no, I’m not referencing their net worth.) The answer is the prepaid card. These celebrities have, at one time or another, linked their names to one.

And while the celebrity endorsements of these reloadable cards have slowed down considerably (and some celeb cards have gone bust), no doubt in response to flack from the media and consumer protection groups, the cards themselves are as popular as ever. According to research from The Pew Charitable Trusts, roughly $65 billion was loaded onto prepaid cards in 2012. That’s double the amount from 2009.

The prepaid card industry got rolling following the passage of the CARD Act of 2009, which, among other things, put restrictions on credit card fees and made their prepaid counterparts, which were left largely unregulated, more appealing to banks. The appeal extends to consumers as well, as prepaid cards are marketed as a safer alternative to cash and a means to control your spending.

So how do they work? Essentially like a debit card without the linked bank account. You purchase a card—at banks, gas stations, grocery stores or other convenient locations—activate it, and load money onto it (some cards also accept direct deposit). Then you use it much like you would a debit card. You can shop online, visit an ATM, and when the money runs out, you either deposit more or stop spending.

If it sounds like a useful budgeting tool, that’s because it can be, says Lynnette Khalfani-Cox of TheMoneyCoach.net. “If you want to have a card that stays loaded for a certain purpose—some people use it to shop at the grocery store or for entertainment or dining out—you load a certain amount on it and you’ve allocated that you’re going to spend $200 a month on groceries,” says Khalfani-Cox. “Once you hit your $200, it’s gone. Then you know you’ve got to stop spending. It helps reinforce the budgeting behavior and helps people really manage their spending wisely.” According to The Pew Charitable Trusts, 67 percent of prepaid users use the cards to avoid credit card debt, and 66 percent use them to avoid spending more money than they have.

The fine print is that there are fees—often high ones—associated using a prepaid card. In fact, a report from CardHub.com found that prepaid cards carry an average of 11 different fees, with annual costs ranging from $0 to more than $400.

That makes picking the right card (and reading the terms and conditions) paramount. It also means you should explore all of your options before settling on prepaid as a primary means of spending for your hard-earned cash. Here, four things to consider when choosing a card:

* The fees can be high and wide-ranging. Depending on the card, you may pay transaction fees, monthly and annual charges, ATM fees, application and processing fees, and direct deposit fees. “There are no federal laws or regulations that [provide] guidelines for these fees, so if I wanted to introduce a card, I could charge whatever I want. Consumers really need to check the terms and conditions of these cards to fully understand the fees they come with,” says Bill Hardekopf, the founder of LowCards.com. Beware of celebrity-endorsed cards in particular—Lil Wayne does not have your back here. Instead, find a card offered by a major bank or credit card issuer. Picks from Hardekopf: American Express Serve, Chase Liquid and the H&R Block Emerald Prepaid Card.

* There are budgeting alternatives. Some prepaid card users are unbanked, meaning they don’t have a bank account and use the card as their main means of spending money. If you can’t qualify for a bank account, a low-fee prepaid card is a good alternative. But the Pew research found that 59 percent of prepaid card users also have checking accounts. Those people are likely using the cards as a budgeting tool, as Khalfani-Cox noted above, loading a set amount onto the prepaid card to control spending. But doubling up may mean twice the fees if your checking account comes with a monthly charge as well. Instead, skip the prepaid card and use a tool like Mint.com or You Need a Budget to watch your spending. If you’re using a prepaid card to dole out money to your kids, open a checking account linked to your own and transfer money to them in increments instead.  They can access it with a debit card.

* Prepaid cards often, but not always, come with loss or theft protection. Many card issuers extend FDIC protection or zero-liability policies to prepaid cards, meaning if your card is lost or stolen, you’ll be covered. Be sure to double check that the coverage is offered. With the exception of payroll cards (used by employers as an alternative to paper checks or direct deposit), there are no federal consumer protections requiring reloadable prepaid card issuers to limit losses.

Note: Prepaid cards can limit your exposure in the event of a data breach. If your card number turns up in the hands of a thief, he or she will have access only to the amount of cash you’ve loaded on the card, rather than the entire checking and savings account balance that a debit card number might offer.

They will not impact your credit. “Some people have the misconception that a prepaid card might help you build your credit rating. No, that’s not possible,” says Khalfani-Cox. If you don’t have the credit history to qualify for a standard credit card, Hardekopf suggests a secured card as an alternative. Consider it a credit card with training wheels. “Just about anyone can get a secured credit card, because you have to put up a deposit. They come with fees, too, but they also help you build credit if you pick the right one.” By that, he means selecting a card that reports to the credit bureaus. Hardekopf maintains lists of cards for people with bad or no credit on his site.

—With Arielle O’Shea and Kelly Hultgren

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