The late rush into prepaid banking by most of the big national banks might make your scratch your head a little bit.  Why is Chase’s Liquid card on the market when I can get one of their regular credit cards or just link my bank account to the card?  Why is American Express, known for cultivating high-end consumers especially with its famous Black Card, now offering two different prepaid credit card options, including its latest offering called Bluebird?  Why do I increasingly see large displays at convenience stores and gas stations for various prepaid cards of all different kinds? A I missing something, who uses these things?  Just yesterday, US Bank bought a prepaid card operator in order to jump into the game as well. Also, various travel blogs, including ThePointsGuy.com, Flyertalk, and The Frequent Miler have had long running debates about the merits of these cards.

An article at northjersey.com  does a great job of explaining the broader prepaid market and explains why it is becoming much more popular.  You may want to read it in depth for yourself as it offers a broader explanation of why this is a market that seems to make sense for both banks and consumers.  Simply put there are two valid reasons for getting one of these cards, but even then they should probably not be a long term strategy.

Reason #1:  Your credit score is too low to get a credit card, or you can’t seem to find a way to get a checking account. 

In the aftermath of the credit crisis some folks have found themselves frustrated by banks.  They may have bounced too many checks or had to many overdraft fees.  Many may have been in such dire straits that they have been banned from using certain banks and find themselves unable to access the regular banking market.  More commonly, many may have found that their credit score is in the toilet, but they need a credit card in order to function in the modern economy, particularly with online shopping and bill payment.  A prepaid card, which works exactly like a credit card in its acceptance and payment processing probably seems like a Godsend.  You can load funds onto the card and conduct yourself just like any other person with any other credit card.  Also, many of the cards allow direct deposit from an employer and direct bill payment to just about anybody (sometimes even including mortgage companies, landlords, and such) so you also have near checking account like functions that way.  Finally, although some cards have fees you can usually get at least a few ATM cash withdrawals from the card as well.  All this without a credit check or really any requirements at all on your credit history.  You can even pick up the American Express Bluebird card at Wal-Mart.

Banks of course like this because they are exposed to nor risk (it’s all your money) and they charge you numerous fees to use these services.  There is often at least a $4 load fee for funds, and numerous other charges can be raked up as well.  Of course, they also collect those processing fees from merchants just as though the card was a normal credit card.

Here is a sample of what Consumer Reports said about prepaid card fees in its 34-page review of 16 popular cards:

• 9 charged activation fees, ranging from $3 to $14.95.
• 13 charged monthly fees, ranging from $2.95 to $9.95.
• 14 charged ATM withdrawal fees of $2 to $2.50 — not including surcharges imposed by ATM owners.
• 12 of 16 imposed a fee that ranged from 45 cents to $1 to check the balance on the card at an ATM.
• 5 charged fees that ranged from $2.50 to $5.95 if the cards were inactive for a prescribed length of time, typically 3 months.

Clearly, this can be a good deal for banks.

Reason #2:  To play the travel miles and points games.

Perhaps those most ecstatic over the prepaid bank revolution were not the poor of credit and the unbanked, but rather the miles and points junkies who have long salivated at ways to get points and greater bonuses for things like mortgage and tax payments which are typically not chargeable on credit cards.  By using prepaid cards they could now finally therefore rack up large numbers of miles for big bills that they pay every month.  Moreover, many of the best rewards cards require big early spending in the first few months in order to trigger the full 50k point signup bonus or whatever promotion they are offering.  These cards offered ways to goose minimum spending by buying prepaid reload cards with the new credit card they were trying to use enough to meet the minimum spending requirement.  Finally, points enthusiasts loved the idea of basically being able to buy cash, create points out of thin air, and all for a low “load” fee.  Even more powerfully were 5X points bonuses often offered at office stores for certain cards, allowing tens of thousands of points to be conjured out of thin air.

These folks tended to be high worth individuals and savvy enough to avoid the other miscellaneous fees.  When done right and assuming no crackdown by either their credit card issuing bank, or some office store having to sell thousands of dollars of reload cards constantly, this could be extremely lucrative.  So much so that in a a year of doing this you could probably earn yourself enough points for a multithousand dollar seat in business or first class.

Of course the banks still make a little money on various fees with these folks and are happy to see them using their product, but they are not the intended audience.  The player who was most burned by this were the various stores and institutions, like Office Depot, CVS, and Wal-Mart, selling the reload cards for the prepaid cards (the Vanilla cards have been most popular).  They would pay a large swipe or transaction fee to the credit card company the points junkie was using, and not actually sell any of their merchandise.  Many have now required cash only.  Some banks, like Citi, also would frequently treat these purchases as cash advances causing a large cash advance interest charge.

So, are they worth it?

I believe they are not worth it.  The unbanked should try to become banked, and unless this is literally your only option other than carrying around wads of cash and constantly going to the post office for money orders, the fees can be hefty and hard to avoid.  Even for all but the savviest and smartest points junkies, those able to play the game sparingly enough to not raise red flags but often enough to get the bonuses, the cards are a bad deal.

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Related Resources:

1. Personal Finance 101: Credit Cards, The Miles and Points Game
2. Stories on Credit Cards
3. The Best Credit Cards for Travelers
4. The Three Best Hotel Credit Cards Reviewed
5. Personal Finance 101: Credit and Credit Cards
6. Personal Finance 101: How Does a Credit Card Work
7. Christmas Shopping, App-o-rama, and Credit Card Signup Bonuses: A Perfect Team
8. Credit Card Points/Miles: How Can I Use My Miles?
9. A Couple Tuesday Morning Shopping Tips

Today is American Express’ small business Saturday.  Amex gives a $25 statement credit for purchases at participating small businesses if the purchase is at least $25.  I looked on a map near my home and there are LOTS of participating merchants!  Enjoy!  All you have to do is register your card here. 

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Related Resources:

1. How To Use American Express Membership Rewards Points