Prepaid cards: once a niche, now mainstream

Rising fees have chased millions of people away from banks and into prepaid debit cards.

In just a handful of years, prepaid cards have become the fastest growing payment method in the U.S. Just this week, American Express became the first mainstream financial company to offer a prepaid card.

But the cards have problems of their own. Complex fee schedules. Few of the consumer protections afforded to bank and credit card customers. No ability to build credit history.

Consumer advocates are raising concerns and demanding more oversight and at least one state is investigating prepaid card issuers. The Consumer Financial Protection Bureau is expected to step up oversight of the industry when it launches in July.

"People are using prepaid cards as checking accounts and the government ought to regulate it similarly," says Suzanne Martindale, staff attorney for Consumers Union, a nonprofit advocacy group that is concerned about unfair prepaid card fees.

Even so, Americans spent $140 billion using prepaid cards in 2009, according to the latest data available from the Federal Reserve. That's a 21.5 percent increase each year over four years. The amount of money loaded onto the cards is expected to reach $552 billion in 2012 from $330 million three years ago, according to the Mercator Advisory Group, a research firm.

Prepaid cards have gone mainstream by catering to the ranks of the unbanked — people who don't have a bank account. Nearly one in five Americans are unbanked, a 2009 government report found, and the number is growing.

Prepaid cards can be used to pay bills or buy merchandise in the same places a bank-issued debit card can be used. So it's no wonder prepaid is the fastest growing method of payment over the last five years. This year, the IRS issued tax refunds on prepaid cards to about 600,000 bank account-free households. Social security payments for the unbanked have been loaded onto prepaid cards since 2008. And a growing number of small companies pay employees using the cards. On Tuesday, American Express joined the fray. The card giant launched a prepaid card in an effort to expand its customer base.

Most new prepaid card customers are seeking refuge from new and escalating fees, consumer advocates say. Among them: $3 to print an account summary at a Bank of America ATM; $12 a month for checking accounts with a balances below $1,500 at Chase and Bank of America; overdraft fees of $35 that most banks charge.

"Even the smallest fee can upend the world of people who are functioning on a break-even basis," says Rachel Schneider, a vice president at the Center for Financial Services Innovation, an organization that works with nonprofit and government groups to look for solutions for the unbanked. "It could mean not having the $2 fare to catch the bus to work."

Pioneering the push to prepaid cards are companies such as Green Dot Corp., NetSpend Holdings Inc., Mango Financial and SmartyPig. They sell cards mostly through big box retailers like Wal-Mart, or at supermarkets and drug stores. The cards come with a Visa or MasterCard logo, and most allow people to use the cards to pay bills online.

Frustrated former bank customers represent a big share of Green Dot's new customers, says Steve Streit, founder and CEO of the Monrovia, Calif.-based company. The largest of the prepaid card providers, Green Dot has more than 4.3 million cards in circulation, a 230 percent increase from three years ago. Between January and March, $4.6 billion was loaded onto the company's cards, 62 percent more than the same period last year.

Several $35 overdraft fees over a three month period left Erin Gamboa's checking account $200 in the red. With her budget too tight to absorb that and other mounting bank fees, the divorced, single mother of two moved her financial life to Green Dot in February. Now, her $850 bimonthly paycheck is deposited directly onto a prepaid debit card. She uses the card to pay for everyday purchases and to pay bills online. She gets a daily text showing her account balance.

"This is just convenient," Gamboa says.

Green Dot's revenue rose to $364 million last year from $258 million in 2009. Competitor NetSpend Holdings Inc. reported revenue of more than $275 million in 2010, up from $225 million the year before. NetSpend's profits were $24 million in 2010, up 33 percent from the year before.

Card issuers make money in two ways. They charge fees to customers to activate, reload and maintain thecards. Merchants also pay a fee every time a card is swiped to make a purchase. Fees charged to customers represent 21.6 percent of revenues for Green Dot and 29.8 percent for NetSpend. The growth ofprepaid cards is also boosting profits at retailers. Wal-Mart Stores, for example, makes 66 cents on each cardit sells. Retailers are also betting that people will use that card in their stores after they buy or reload them.

The fees prepaid card customers pay can add up quickly. First up: an activation fee to secure a card. Such fees average $5 but at least one provider, Millennium Advantage, has charged $99.95 according to the nonprofit group Consumers Union. After that, customers typically pay $3 to $10 each time they load the cardwith cash. Monthly maintenance fees average about $5, but can be double that amount. ATM withdrawals can cost $2.50. Printing an account summary can cost up to $5.95. And some cards even charge to close the account.

There are ways to reduce costs associated with prepaid cards. Some are free if purchased online. And several card issuers waive reloading and maintenance fees with a minimum direct deposit or number of transactions.

But good luck figuring out what other fees must be paid. Consumer advocates say each card provider has a different fee structure.

Green Dot has 9 different fees. NetSpend, with 2.3 million active prepaid cards in circulation, has 11 fees, including a $1 charge if an ATM transaction is declined. (NetSpend does offer a perk that banks don't: one overdraft of up to $10 each month without penalty. Dan Henry, CEO of NetSpend Holdings Inc., says 90 percent of customers overdraft by that amount on a regular basis.)

The web of prepaid card fees has attracted the attention of law enforcement. Last month the Florida Attorney General's office began investigating the industry after consumers complained about hidden fees. Subpoenas were issued to five companies — First Data Corp., Account Now Inc., Unirush Financial Services LLC, Green Dot and NetSpend. Officials at the firms say they are cooperating and insist that they disclose their fees.

Prepaid cards have other drawbacks. Their use isn't reported to major credit bureaus so they don't help build a user's credit history or credit score. For someone who primarily uses a prepaid card, that could make it harder to get a loan later on.

Funds added to a card are FDIC insured, but the cards aren't protected by the federal laws that limit creditcard customer losses to $50 for fraudulent charges. But prepaid providers set their own rules. Green Dot customers, for example, pay $4.95 for a replacement card and could lose up to $500, depending on how quickly the loss is reported. NetSpend's customers lose nothing, says Henry, but pay $9.95 for a new card.

American Express prepaid cardholders won't pay anything toward fraudulent charges. They also won't be charged monthly maintenance, activation or balance inquiry fees, said Laura Kelly, Amex's senior vice president of product development & marketing for global payments options.

That's better than most prepaid cards, but there are still fees to watch for. Reloading the card at a store? Fork over $4.95. Withdrawing money at an ATM? After one free trip to the cash machine each month, that'll be $2 a pop.