A lot of folks are using prepaid cards these days as a payment method. The Federal Reserve estimates that a full 17% of Americans are using them. This number is likely growing much bigger with all the people that are dropping their credit cards and getting rid of debt. Just be aware that security and consumer protection for prepaid cards are nothing like those offered by traditional credit and debit cards.
You can reload your prepaid cards and use them like traditional debit cards or charge cards for transactions. Most prepaid cards also look like a standard debit or credit card, with markings like the logos of Visa or MasterCard, and account numbers. Consumers who are not qualified to get a credit line, and those who are underbanked or unbanked tend to be the biggest users of prepaid cards. Those who don't trust banks also turn to prepaid cards. However it's important to keep in mind that prepaid cards can leave you more vulnerable to fraud. Regulators are now trying to change this.
Areas that lack protection
Consumer protections offered by prepaid debit cards are voluntary and can be revoked or revised by the issuer at any given time and for any given reason. The FDIC also doesn't typically regulate or insure the money that is loaded on these prepaid cards (as they do with traditional banking accounts), but some issuers are in fact backed by the FDIC. Consumers whose prepaid cards are not backed by the FDIC are not guaranteed to recover their money in full, in the event that the issuer goes belly up.
Also, when you report your prepaid card lost or stolen, and it is used in a fraudulent way, you will not get the same statutory and regulatory safeguards for the recovery of your money. Cards issued by banks and credit card companies have a Zero Liability Clause that frees the cardholder from financial responsibility from unauthorized purchases (certain terms and conditions apply, but in general you can recover all the money that is stolen).
When you report your debit card lost or stolen within 2 business days of it occurring, your personal liability is limited up to $50. If reported after 2 business days, your liability rises to $500. If it takes you more than 2 months to report the theft, you will likely be held liable for the full amount. Credit cards give a $50 limit no matter how soon you report it lost or stolen.
When you have a prepaid card, things are different. It isn't clear whether or not the Electronic Fund Transfer Act applies to these cards, as is mentioned in Green Dot Financial's SEC filings. In this case, the card issuers have the option of whether or not they want to protect you from fraud. You should also be aware that there are loopholes within the MasterCard and Visa Zero Liability programs. So, for instance, ATM transactions and PIN debit transactions that aren't routed over the Visa PIN network aren't covered by Visa's fraud protection.
Filing billing disputes with prepaid card companies is difficult since consumers don't have the same leverage as with regular credit card companies. Federal law protects you with a traditional card by allowing you to avoid making any payments until your dispute has been settled. With prepaid cards, your money has already been taken and you're not guaranteed to get it back unless the card issuer wants to replace it. These issuers also aren't required to by law to give consumers the option of dispute resolution, so this is also voluntary on their part.
Keep yourself protected
The federal government is facing a lot of pressure to make the same legal protection available for prepaid cards that they now offer for credit cards. Since prepaid cards aren't connected with any bank accounts, they are not regulated by the EFTA and Regulation E, so regulators have to work to fix this.
Credit cards, gift cards and debit cards have all had to adopt the Credit Card Accountability Responsibility and Disclosure Act regulations. But prepaid cards were left out. Consumer advocates argue that prepaid card disclosures are feeble or non-existent.
If you are a prepaid debit cardholder, be aware. You should read the fine print thoroughly to ensure that you know what the issuer's policies are on theft and fraud. Then afterward, take what you find with a grain of salt.
This post comes to you from the NerdWallet.com team of personal finance bloggers and experts in helping consumers find the best rewards credit cards.