How do prepaid cards work?

Thinking about a rechargeable prepaid card? There are currently over a dozen types on the market and many variations that can make them a great or terrible financial choice. Here’s what you need to know about generic prepaid cards: how they work, when to use them, and how to get them.

What is a prepaid debit card?

Prepaid cards look like credit cards and spend like credit cards, but there is no credit behind them. Technically, these are debit cards – when you use them, you are spending your own money, not the bank’s money. This means that you will not pay interest on a prepaid card like you would on a credit card.

Because prepaid cards are connected to major card networks – Visa, Mastercard, American Express and Discover – they can be used anywhere debit cards can be used: buy groceries, fill up with gas, and even pay bills online.

One of the disadvantages of prepaid cards is hidden fees. Unlike credit cards, which are required by law to disclose their terms upfront, there are no regulations that require pre-purchase fees to be disclosed with prepaid cards.

According to the Consumer Financial Protection Bureau, some of the common fees associated with prepaid cards include monthly fees, transaction fees, inactivity fees, and even bill payment fees. Commission structures vary, so it’s important to read the disclosure.

Debit Cards vs. Prepaid Cards

Unlike traditional debit cards, you don’t need a bank account to use a prepaid card. You simply load dollars directly onto the card and then use that balance to make purchases. When the card balance drops too low, you reload more money.

For the more than 7 million households that do not have a checking account, prepaid cards can offer the ease of card-based shopping without requiring a bank account.

Like a regular debit card, a prepaid card does not require a credit check. On the other hand, it won’t help you get a loan either, as credit bureaus don’t track prepaid and debit card spending.

Like regular debit cards, prepaid debit cards offer some protection. Even those that are not issued by a bank offer zero liability protection of the card-named payment network, such as Mastercard or Visa. If you report the loss or theft of your registered card to the issuer in a timely manner, most of them will restore your original balance and issue a new card.

In other words, a prepaid card works like a debit card, minus many risks and, of course, a bank account.

When do prepaid cards make sense?

The popularity of prepaid cards is undeniable, partly due to their versatility. Here are some common reasons why you might choose a prepaid card over other options:

• Do you have bad credit or no credit: While there are credit cards for those with bad credit, if you don’t want to go that route, prepaid cards can offer the convenience of a card for short-term spending.
• You want to avoid overspending: With a prepaid card, it’s impossible to overspend – it expires when the preloaded dollars run out – making it a useful first card for teens or those recovering from debt.
• You don’t have a bank account: Because prepaid cards are preloaded, you don’t need to link a checking or savings account to use them.
• You don’t want to use cash: If you don’t want to carry a wad of cash with you when you travel, or just don’t feel safe paying cash only, a prepaid card is a good alternative.
• You want to share travel expenses without a credit card: If you’re traveling with someone and both of you want to spend cash on common expenses, putting cash on a prepaid card together can be a solution. So you can use prepaid cards to book a hotel room or rent a car without relying on one person’s credit card or one of you reimbursing the other.

How to get a prepaid debit card

When choosing a prepaid card, look for one that suits your specific needs. For example, some prepaid cards allow you to pay your bills online and even make automatic monthly payments. Some of them will make payments using an electronic check issued by the card company or allow you to withdraw cash from an ATM using a special PIN.

Managing your prepaid card is easier than ever with online account access. Many cards, such as Green Dot, Walmart MoneyCard, and Amex’s Bluebird and Serve, offer apps to manage your accounts right from your phone. Need to put more cash on your card? You have five options:

1. Transferring money from a bank account.
2. Ask your employer to transfer your salary to your card.
3. Transfer money from your PayPal account.
4. Reload it at a retail store like Walmart or Walgreens.
5. Use a reload card that works like a gift card.

bottom line

A prepaid card allows you to load your own money and use it for transactions. Considering that the loan is not issued, such cards will not help you build a credit history.

These cards are especially useful for people without bank accounts or those facing credit problems, but they offer a lot of features and anyone can use them. While prepaid cards come with some consumer protection, keep an eye out for hidden fees.

Melody Warnick is a former personal finance contributor at CreditCards.com.