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Why consumers flock to prepaid debit cards

Rama Malladi, CFA, CAIA, FRMPrepaid debit cards are on fire. These cards -- in which the customer chooses how much money will be available for purchases -- represent the fastest-growing noncash payments in America, according to a Federal Reserve study.

There are three main reasons for this phenomenon, says Rama Malladi, adjunct professor of finance at the College of Business Administration and Public Policy at California State University, Dominguez Hills in Carson, Calif. Malladi outlines what they are and offers tips for discovering whether prepaid debit cards are right for you.

What's the difference between a prepaid debit card and a credit card?

A credit card has a credit limit decided by the card issuer (i.e., a bank). A prepaid debit card is funded by the customer, so the customer chooses how much money to deposit into (a) prepaid debit card. (The) credit card approval process requires a credit check of the customer. (A) prepaid card does not. Credit scores are not necessary to obtain a prepaid debit card.

A typical credit card has (a) late payment fee, (a) prepaid card does not. A typical credit card has (an) interest rate charge on outstanding balances; (a) prepaid card does not. A typical credit card may not have a monthly fee, whereas most prepaid debit cards have a monthly fee.

A credit card can be obtained by filling out a credit application form issued by a bank. A prepaid debit card can be purchased at a store such as Wal-Mart, Target, Vons, etc. A prepaid debit card is a debit card, and more similar to a bank debit card (without a bank account) than a credit card.

Why are consumers flocking to prepaid debit cards right now?

According to the Federal Reserve Payments Study in 2010, prepaid cards are the highest-growth noncash payments in America. Prepaid card transactions grew at a compounded annual rate of 21.5 percent, whereas credit card transaction(s) grew at a negative 0.2 percent. Though growing rapidly, prepaid cards represent a small share of noncash payments (5.4 percent by number of transactions).

There are three main reasons why consumers appear to be flocking to prepaid debit cards.

  • Aftermath of credit recession: According to the Federal Reserve Flow of Funds report, the credit growth in America has declined from 9.6 percent in 2006 during the height of the credit boom to negative 2.2 percent in 2010 and has remained low ever since. This is mainly because of a general consumer aversion to credit, lack of credit available due to stringent lending standards and lower demand due to (a) decline in the number of credit-eligible borrowers.

  • Higher fee to maintain a bank account: According to the October 2011 report "Still Risky: Bank Fees and Disclosures in the States" by The Pew Charitable Trusts, a nonprofit policy research group in Washington, D.C., 89 percent of the checking accounts offered at the 12 largest U.S. institutions involve bank fees. Due to limited opportunities to make a profit as a result of (a) low-interest rate environment and tighter consumer regulations, banks are trying to be as innovative as they can to raise revenue. As a result, consumers are trying to avoid bank accounts altogether. Prepaid debit cards allow a consumer to avoid both the credit card-related fee as well as (the) bank-related fee.
  • Ease of use and general availability: Prepaid cards can be purchased in any retail store. Popular prepaid cards can be purchased in Wal-Mart, Target, Albertsons and any of the 60,000-plus locations in America. In addition, these cards can be reloaded easily in these stores (without going to a bank) or online.
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