What are prepaid cards?

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Also known as “stored-value” cards, prepaid cards are issued by banks and financial institutions with a pre-determined amount of funds loaded on. Although sometimes considered credit cards, in many ways, prepaid cards actually work in a completely opposite way compared to credit cards.

This is because, rather than purchasing items with funds that are borrowed through credit, consumers are actually purchasing products and services with funds that have already been placed on to their card.

Over the past few years, the popularity of prepaid cards has increased substantially. One of the most common and recognized type of prepaid cards are “gift cards.” These cards contain a pre-loaded amount of funds for use that may be utilized with various merchants, such as restaurants, retailers, gas stations and other merchants.

History of prepaid cards

While the first credit card was issued in the late 1950’s by Bank of America, prepaid cards did not come about until the 1970s and were not widely used until more recently. In the early 1990s, many large retail chains adopted these cards and began using them in lieu of paper gift certificates.

Today, the size of the prepaid card market is substantial. The industry has grown exponentially, particularly since the financial crisis of 2008 and 2009, which contributed to the growth in the number of “unbanked” U.S. households (those without access to a bank checking or savings account). In turn, nearly 18% of these unbanked households made use of at least one prepaid card in 2011. This compares to just 12% of unbanked households in 2009.

How prepaid cards work

Prepaid cards start out by having a certain amount of funds “loaded” on to them via the issuer of the card. Then, when the card is used for payment at a merchant, the cost of the product or service being purchased is deducted from the available balance on the card.

It is important to note that prepaid cards are not the same as secured credit cards. In many ways, a prepaid card works in similar fashion to a debit card where, once there are funds available, a consumer may use the card anywhere that accepts it. However, once all of the funds have been used on a prepaid card, additional money must be added. Otherwise, the card will no longer be usable.

Conversely, a secured credit card requires that an individual make a cash deposit – usually in an amount between $200 and $5,000 – before the card is available for use. The bank that issues the secure credit card will then hold on to the consumer’s deposit in the event that the individual defaults on their secured credit card account.

A prepaid card may be categorized as either single purpose or multi-purpose. A single purpose prepaid card typically may only be used at one particular merchant or for a specific purpose, whereas a multi-purpose card may be used anywhere that the card brand whose logo they contain is accepted. This is typically the case with prepaid VISA or MasterCard prepaid cards, which can be used at all establishments or businesses that accept VISA or MasterCard.

Today, prepaid cards are used in ways other than as mere gift cards for products and services. Some alternate uses of prepaid cards include:

  • Electronic Benefit Transfer (EBT) – In 1996, federal welfare reform mandated that food stamps must be replaced with prepaid benefit cards that would be accepted at numerous merchants. Instead of issuing food stamps, the program would directly deposit funds into the recipients EBT account.
  • Paying “Unbanked” Employees – Prepaid cards have also come about as a way for employers to pay their employees who do not have access to a bank checking account.
  • Flexible Spending Accounts (FSAs) – The use of prepaid cards also has a place in employees’ flexible spending accounts where cash is deposited on to the card and is then made available for paying various medical related expenses.

Because prepaid cards are more lightly regulated than bank accounts, some card issuers may charge fees unless the card holder keeps a minimum balance on the card. Some cards may also charge an initial activation fee prior to use.

Providers of prepaid cards

Over the past several years, many of the largest banks in the U.S. have become big players in the prepaid card market. These institutions include Wells Fargo, JPMorgan Chase, American Express and PNC Bank.

In many instances, a prepaid card may be obtained by simply purchasing the card at a local retail establishment or online. In other cases, an individual may be subject to a credit check as well as to a minimum balance requirement.

Advantages and concerns when using prepaid cards

As prepaid cards have become more popular, their many advantages and disadvantages have become more apparent. Some of the biggest benefits of using a prepaid card include:

  • Convenience – Because prepaid cards may typically be used in a variety of locations, consumers can take advantage of their convenience.
  • No credit requirements – In most cases, consumers are not subject to a credit check prior to obtaining a prepaid card. So users will not have to worry about being declined because of weak credit histories or low credit scores.
  • No linking to a bank account – As prepaid cards are not linked directly to one’s bank checking account, the risk of identity theft is decreased – even if the prepaid card is stolen.

While there are many benefits to using prepaid cards, there are also some concerns that consumers need to understand:

  • No benefit to credit score – Because consumers are essentially using their own money with a prepaid card, use of these vehicles will not improve one’s FICO credit score.
  • Fees – Financial institutions typically make money on prepaid cards through the charging of monthly fees and/or activation charges.
  • No fraud protection – If an individual has a debit or credit card stolen and used fraudulently, there are protections available. With prepaid cards, however, these protections are typically not available.
If an individual has a debit or credit card stolen and used fraudulently, there are protections available. With prepaid cards, however, these protections are typically not available.

Disclaimer: NetCredit is a direct personal loan provider and does not provide financial advice, nor does it vouch for any vendor or service mentioned on our NetCredit personal finance blog or online consumer loan glossary. Always research and perform due diligence on any service provider or vendor before deciding to use them, and we recommend that you speak with a financial advisor regarding all decisions that will affect your finances.

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