Prepaid cards: how they work
On the high street, a prepaid card is indistinguishable from any credit or debit card.
They can be used wherever the issuer - Visa, Mastercard or Maestro - is accepted, and they work with chip and PIN, or for online transactions.
There's one big difference, however.
How prepaid cards work
Unlike credit cards which explicitly loan us the money until we pay it back, and even debit cards that "borrow" the money until it can be drawn from our current account, a prepaid card must be loaded with money first and we can only spend what we've loaded it with.
Cardholders can usually top up via bank transfer, with a debit or credit card, at a post office or with a participating retailer.
Most prepaid card providers make money by asking cardholders to pay for those various methods of loading money on to the cards.
Alternatively, or sometimes in addition, they take a fee when the cardholder uses the card for spending or to take out cash. Some prepaid cards charge fewer fees and instead ask for a flat monthly fee for holding the account.
Why get a prepaid card?
Loading is a pain and paying can certainly be painful compared to free to use debit cards. So why go prepaid?
Not having a credit facility makes prepaid cards a safer way to spend.
Cardholders can set money aside for particular uses - spending at the sales, for example - and because they've limited themselves to a certain amount beforehand, they can't give in to the temptation to splurge.
For that reason, and since they're accepted worldwide, prepaid cards can also be particularly good for holiday spending.
Proponents also claim that they can shield consumers from losing large amounts of money as a result of online fraud. Kevin Harrington, the then MD of the Global Prepaid Exchange had this to say after the PlayStation network hack in early 2011:
"While there is probably nothing gamers could have done to prevent the hackers accessing their details, they could have protected their finances by using a prepaid card instead of a credit card to make online transactions."
Another safeguard against loss was introduced in May 2011 when rules regarding electronic money made it more difficult for providers to refuse to refund cash loaded on to a card.
Poor history options
Because prepaid cards are not a form of borrowing, there are no credit checks involved in applying for one.
For that reason they're popular with some consumers who have a very poor credit history, including bankrupts.
However, as we'll see, prepaid cards always charge fees for basic transactions and lack some forms of consumer protection.
It's worth noting, then, that all basic bank accounts must now provide a free to use payment card, usually in the form of a debit card.
Nevertheless, some prepaid cards remain a good option for those with poor credit either where basic bank accounts aren't available, or as a way of helping to build or repair credit history.
Credit builder cards work by treating the holding fee like a very small loan; paying for the card each month appears as positively repaid borrowing on a credit report.
Under-16 card options
Some cards have minimal age restrictions, with some specially designed for children and teenagers: we know of a couple that are available for children as young as eight.
In these cases providers only offer prepaid cards to younger users when the main account is managed by someone aged 18 or over, such as a parent or guardian.
Other prepaid card issuers provide additional cards for those aged 13 or over, again on the condition that the main card and account are registered to someone aged at least 18.
Prepaid cards can be seen as a way to teach youngsters how to manage their money effectively, and they're safer than carrying cash.
There's also a strong case to be made for allowing teenagers to have a secondary card that doesn't have a credit option, in case of emergencies.
Odd as it may sound, some prepaid cards offer rewards in the form of cash back, just like some debit and credit cards.
The cash back is usually restricted to particular high street retailers, and any potential earnings must be balanced against the cost of having the card, which can vary greatly (see below).
Fees and charges
As we noted above, prepaid providers aren't issuing cards out of the kindness of their hearts.
Here's a selection of some of the fees to look out for:
- Initial application fee - usually between £5 and £10. Some charge as little as £1.
- Reload fee - some prepaid cards will charge for each and every transaction, others charge a flat fee each month (see below).
- Purchase fee and/or monthly fee - some prepaid cards will charge for each and every transaction or they may charge a set amount each month (see below for more on this).
- ATM Fee - the charge for withdrawing cash via an ATM.
- Foreign Transaction Fee - a percentage of each transaction abroad, typically 2.75%. Some also charge withdrawal fees on top of the transaction charge. Cards designed specifically for use abroad e.g. a Euro or Dollar based travel card may not incur these charges when we use them to spend in that currency.
- Reissue fee - with ordinary cards, users are automatically sent a new one when the expiry date approaches. When prepaid cards get close to expiry, cardholders may be charged for another card to be issued.
- Dormancy fee - if the card has a balance but hasn't been used or has expired without the balance being claimed by the cardholder, the card issuer may charge a dormancy or inactivity fee. More on these fees here.
Monthly fees and initial fees are applicable to some accounts. Others charge low standard fees but will cost users heavily if they top up in a different way or use them abroad.
For the first type, cardholders pay a monthly fee for using the card, typically around the £5 mark. In most cases, they then pay no fees on purchases made in the UK - there's usually a foreign transaction fee.
The best way to see what we mean is to look at some real world examples, so here are two pay monthly cards and their fees, as correct at the byline date:
- Cashplus MasterCard ActivePlus (more details) : £5.95 application fee, then card holding fee of £5.95 per month. No charges for transactions made in the UK. ATM withdrawals cost £2. Free to top up with up to £1,000 per month, whether in cash or electronically.
- CardOneBanking Prepaid card (more details) : Free card then £12.50 monthly management fee. Free to top up through BACS, £1 via Post Office Barcode and free to use for purchases. Standard ATM withdrawals in the UK cost £1.50, while getting a cash advance will cost £5 a time.
Pay as you go
With PAYG prepaid cards there's no monthly fee, but cardholders usually pay a fee for purchases and other transactions made with the card.
These fees can range from less than £1 to around 2.95% of the value of the transaction, and additional charges may be added on top for purchases outside of the UK as well as ATM withdrawals.
Here's one example of the kind of charges we can expect with a pay as you go prepaid card, accurate at the byline date:
- Cashplus MasterCard FlexiPlus (more details) : £9.95 application fee; no monthly holding fee. All UK transactions subject to 99p charge; ATM withdrawals cost £2. Free to top up with up to £1,000 per month, whether in cash or electronically.
Low standard fees
In recent years more prepaid card providers have appeared on the scene, which has helped make the cards that bit more competitive.
However, while some of these cards charge attractively low standard fees, there are high charges to be aware of. Here are two such cards:
- Pockit MasterCard (more details) : 99p application fee. No monthly fee, or fees for UK transactions. 99p fee for all cash withdrawals, and for loading the card via debit card or Paypoint (free when done via bank transfer). Using abroad is expensive: the card charges a 4% exchange fee, plus £2.25 for foreign cash withdrawals.
- Optimum Cash Prepaid MasterCard (more details) : £5 to buy the card then free to hold. UK transactions are free. There's a 2.95% fee for ATM withdrawals; topping up online, by standing order or debit card is free of charge, but via Paypoint or Post Office it'll cost £1.50. Credit card top-ups, however, will incur a 4% fee.
Foreign use cards
Designed especially for use abroad, as mentioned above these prepaid cards often charge preferential fees when used for transactions in their designated currency. While they can be used in other locations or to make payments in other currencies, they'll be subject to higher fees.
Here are a couple of typical foreign use prepaid cards as an example:
- Travelex Cash Passport (more details) : Free to get and use aside from for cash advances (£4 fee applies). A fee, the greater of 2% of the top up or £3, applies to loading the card. There is a minimum initial top up of £50.
- Virgin Prepaid Travel Money MasterCard (more details) : Free to get and top up with debit card but there's an ATM fee of 1.5 Euro or 2 USD, depending on the card currency.
Problems with prepaid
It's clear that fees may be one problem with prepaid cards, when compared with other ways of paying.
Similarly, card holders may have fewer rights when using a prepaid card than they would with a debit or credit card issued by a mainstream bank.
No FSCS protection
For example, many users don't realise that the money stored on these cards is not protected by the Financial Services Compensation Scheme (FSCS); there's more on this here.
The FSCS ensure compensation of up to £85,000 in case of an emergency, such as the collapse of a financial provider.
However, in the case of prepaid and e-payment cards, should the provider become insolvent any funds loaded onto the card are not protected. They'll disappear.
"Before taking out any products, consumers should ensure they should visit our website or ask the provider about FSCS protection," Mark Neale, chief executive of the FSCS has said.
As many prepaid card users only load them up with relatively small amounts at a time, FSCS protection should really only worry regular prepaid users with large balances on their cards - a minority of cardholders.
It's interesting to note that those with smaller balances are actually more protected: under EU law, very small balances on prepaid cards, too small to use if the card provider insists on a minimum transaction value, must now be returned to cardholders.
No section 75
Since prepaid cards aren't a form of borrowing, consumers aren't protected under section 75 of the Consumer Credit Act.
The closest thing prepaid cards have to section 75 is protection on purchases with the CashPlus Prepaid card (more details) which, the card provider says, is extremely similar.
However, protection is provided at the discretion of CashPlus, so it's not the same as the solid legal protection offered under section 75.
Do note that when a prepaid card is issued by MasterCard or Visa cardholders may be able to make a claim under the issuer's chargeback scheme.
Again, though, this protection is nowhere near as strong as section 75: see this article for a full explanation.
No help with debts
As we noted above, prepaid cards are also often used by those with poor credit histories.
There's no risk of running into debt with a prepaid card as it has no credit or overdraft facility and crucially, isn't connected to any personal bank details.
Yet that also means that, unlike banks and building societies, prepaid card providers have no obligation to help people who are struggling with serious debts or on a very low income.
For example, in January 2010, MPs spoke out against prepaid firms targeting benefits claimants and eating into the state aid significantly in the form of charges for use.
For users, as we've said above, prepaid cards are actually very safe: we can't spend more than we have loaded on there.
From a provider or Government perspective, however, prepaid is actually less safe.
The fact that prepaid cards are available without a credit check, and often without any more confirmation of our identity than a valid postal address, means that they're attractive to those involved in money laundering or who wish to buy things online without leaving a paper trail.
With this in mind it'll be interesting to see how these products evolve in the next few years, we'll be watching.