Ditch checking for a prepaid debit card?

Banks better watch their backs. Prepaid debit card providers have never been shy about taking on the banks and competing with traditional checking accounts, and many banks’ efforts to boost fee revenue have left them open to competition from this up-and-coming industry.

Prepaid debit cards survey

To hear prepaid card providers tell it, the case is open-and-shut. Netspend calls its card “a lower-cost alternative to banks.” RushCard touts its prepaid debit card as “the better alternative to traditional banking.”

But are prepaid cards really cheaper than checking accounts? To find out, Bankrate surveyed 18 prepaid debit cards for information on their typical fees.

The conclusion?

Even the best of the prepaid debit cards couldn’t keep up with credit unions, local banks and online banks, many of which still offer attractively priced checking accounts, says Greg McBride, CFA, senior financial analyst for Bankrate.com.

“While there was variation in the fees charged, with some cards charging more fees or higher fees, all of the cards charged fees of some kind,” McBride says. “For the majority of consumers, a low-cost or free checking account remains the better option.”

A la carte versus all-you-can-eat buffet

It’s true that more banks are charging monthly fees for checking these days. In last year’s Bankrate Checking Survey, Bankrate found 45 percent of noninterest checking accounts were considered free, down from 65 percent in 2010.

But if you’re looking to prepaid debit cards to bring down your monthly costs, you may be disappointed. To start with, two-thirds of the 18 cards in the survey had monthly maintenance fees.

But the pricing differences don’t end there. Unlike traditional checking accounts, which offer financial services such as free access to the bank’s ATM network, free customer service and free bill pay bundled together in an “all-you-can-eat” buffet of services, prepaid debit cards charge for a set of specific transactions each time you make them.

So while it’s a drag that many banks are charging an average monthly maintenance fee of $4.37, that’s not even half the average $9.28 per month you’ll spend to conduct a typical month’s worth of personal transactions with a prepaid debit card, McBride says. The latter transactions might include 10 purchases, one out-of-network ATM withdrawal, four bill payments, one customer service call and a balance inquiry at the ATM.

And that doesn’t include check-cashing fees and the cost of loading cash onto a prepaid debit card, which usually involves buying a Green Dot MoneyPak or some other similar transactional service, says Jean Ann Fox, director of financial services for the Consumer Federation of America in Washington, D.C.

“You and I take it for granted that we can waltz by the ATM and deposit, and go into the bank and make a deposit to our account. We don’t pay for that,” she says. “If you are paying $4.95 to load $100 to your prepaid card, that is a pretty good bite out of the money you hoped to be able to spend (on) groceries.”

If you do go with prepaid debit, Fox recommends setting up a direct deposit to avoid such costs.

Overdraft fees change the equation

Prepaid debit cards can be a lower-cost solution for one group of checking customers — serial overdrafters.

Even incurring one overdraft per month can drastically increase the cost of a traditional checking account, Fox says.

“Typically banks will charge you $35 per overdraft of just a few dollars or pennies, depending on what the bank’s parameters are,” Fox says. “So that is the big cost risk of having a traditional bank account that you might overdraw.”

That risk is compounded by the risks to your credit report, says David Jones, president of the Association of Independent Consumer Credit Counseling Agencies in Fairfax, Va.

“It is possible that if you constantly have overdrafts, that information could get into your credit report,” he says. “You’re not going to get any information from a prepaid debit card, and it is not going to help you with your credit report at all.”

Fortunately, there’s an easy way to avoid debit overdraft charges on a traditional checking account. Federal Reserve rules require banks to seek customers’ approval before enrolling them in such programs. Customers can simply opt out, Fox says.

Still, those who have trouble managing a checking account will still be on the hook for overdrafts.

“In order to make a bank account a lower-cost option,” Fox says, “you have to say ‘no’ to overdraft coverage, and then you have to very carefully monitor your available balance so that you don’t write a check that is not covered with the money that you have on deposit or you don’t set up an electronic payment.”

Consumer protection lacking

Because they’re fairly new products, lawmakers and regulators haven’t had time to solidify consumer protections for prepaid cards to the same degree as checking accounts, Fox says.

For instance, prepaid debit card balances are parked at a bank contracted by the prepaid card company. It’s not clear whether an individual prepaid debit card holder’s balance would be protected if the bank failed, Fox says.

“There are questions about the extent to which FDIC (Federal Deposit Insurance Corp.) insurance protects the money that is being held in a pooled account,” she says. “Those accounts have to be structured in such a way that the card issuer can identify the individual persons so that the insurance passes through to protect you individually.”

Fraud protections also are lacking, which could come into play should a thief steal a prepaid cardholder’s payment information, Fox says.

That’s because general-purpose reloadable prepaid cards aren’t covered under Regulation E of the Electronic Fund Transfer Act, which limits debit card holder liability for unauthorized purchases, she says.

That creates an extra burden for cardholders.

“You have to monitor the transactions on your card because you don’t have automatic protections that come with a regular debit card,” she says.