Given the prevalence of electronic payment processing, consumers are becoming ever more dependent on cashless transactions, a trend accentuated by the Covid-19 pandemic. Many Americans, however, do not have access to traditional credit cards and a surprising number have no established relationship with a bank or credit union. Secured credit cards and prepaid debit cards have gained acceptance in response to this need. But what is the difference, and which one is appropriate for a particular individual?
Most of us are well acquainted with debit cards attached to our bank accounts. The card serves essentially as an electronic check, allowing a merchant to receive immediate payment by directly debiting or removing funds from the customer’s account without delay and with minimal risk. Yet for the estimated 9 million households without a bank account, a traditional debit card is not an option. Prepaid debit cards give unbanked or underbanked consumers the same access to electronic payment capability.
As early as the 1990s, retailers issued store-branded prepaid cards as an electronic form of gift certificate for use within their own footprint. However, the 1996 Welfare Reform Act mandated the creation of reloadable “electronic benefits cards” (EBT) accepted by all merchants that participated in debit and credit card networks. This opened the door for financial institutions to offer generalized, pre-loaded debit cards accepted at any establishment honoring debit or credit payments.
Prepaid debit cards can be funded or reloaded at some local merchants, financial institutions, online or in some cases over the phone. Charges are deducted directly from the available balance and are not tied to a bank account, and the cards may be re-funded at will. These cards are essentially an alternative bank account and can be a useful tool for budgeting and spending control even for consumers with a bank account. They do not require a credit check and do not impact credit history.
Secured credit cards trace their origin to a handful of San Francisco Bay Area banks in the early 1980s. The difference between secured and traditional credit cards is the requirement of collateral. Secured cards typically are issued once the applicant deposits a minimum amount (often $200 to $500), which then becomes the effective credit limit on the card. However, unlike a prepaid debit cards, purchased are not deducted from the collateral balance. The cardholder receives a monthly statement and is obligated to pay the card charges just as in a traditional credit arrangement. The collateral is surrendered in the event the borrower defaults.
There are generally two types of customer interested in secured credit cards: consumers with little or no history seeking to build a credit file, and those with damaged credit working to repair their credit history. These cards are excellent vehicles for both types of customer assuming they habitually repay the balance on time. Secured credit card issuers report to the recognized credit agencies, helping to establish a history of responsible use.
As of 2019, both prepaid debit and secured credit cards are subject to the same fraud protection as conventional credit cards, limiting liability to $50 if the breach is reported promptly (and if the prepaid card has been registered with the issuer).
With either type of card, one must shop carefully to minimize fees and expenses. Some come with a plethora of activation, transaction, reloading, and annual maintenance fees that can be oppressive. Features and expenses vary, so it pays to search diligently for the right option. Good sources of information include NerdWallet.com, Bankrate.com and Creditcards.com, where you can read more about each offer and compare costs.
Of course, the downside of each of these cards is the need for a deposit, which can be a significant obstacle for some households. But in certain situations, one of these options may provide essential access to the cashless society and serve as a useful tool for budgeting or building credit.
Christopher A. Hopkins, CFA