When budgets are tight, the concept of paying up-front for a product or service—with cash instead of credit—seems like a smart one. And it can be, in the right situation. The problem, however, is when unsuspecting consumers are hit with lots of fine print, in the form of fees and service limitations.
Here, we examine the pros and cons of two of the most common prepaid products—cell phones and debit/credit cards—to see which are money-savers, which are money-stealers and whether there’s ever a right time to use them.
Prepaid Phones: The Pros
Between downloading apps, text messaging and making international calls, cell phone bills can get high in a hurry. With prepaid phones, however, customers pay a flat rate at the beginning of the month, without ever having to worry about a $7 roaming charge—or a credit check.
“Prepaid phones are great for people who don’t talk on the phone a lot,” says David Bakke, a writer for the personal finance site Money Crashers. “This type of plan saves more money than paying for a monthly plan of 500 minutes, for example, when you never use that many minutes.”
Bakke also explains that prepaid phones do not require signing a long-term contract, which gives the consumer the flexibility to switch phones or providers as needed, sans that pesky termination fee.
Prepaid Phones: The Cons
Customers may be able to save money month-to-month on a prepaid plan, and if they want to use a smartphone, they’ll need all the savings they can get. Without a contract, AT&T is selling the new iPhone 5s for $649.99, as opposed to $199.99 with a two-year commitment.
And aside from higher device costs, Bakke notes another disadvantage: “Some minutes associated with prepaid phones have expiration dates attached, meaning you could lose your minutes if you’re not careful,” he said. There’s also the fact that having access to the latest apps, software and data packages will cost significantly more, potentially negating the aforementioned savings.
Prepaid Debit/Credit Cards: The Pros
Despite all of the recent backlash that prepaid debit and credit cards have received in the media, Leslie Tayne, a financial attorney and debt specialist with Tayne Law Group, recommends them for some of her clients.
“Prepaid credit cards and debit cards not only hedge against the risk of overspending, but they also alleviate the need for worrying about making monthly payments, accruing interest or incurring late fees,” says Tayne. “They essentially help you learn how to stay within a budget, because you are spending only a finite amount of money.”
In a country that’s teetering on the brink of debt-disaster, the fact that prepaid cards ensure that consumers only spend money they’ve pre-loaded to the card is definitely a positive. If you consider the fact that these cards are generally accepted wherever traditional debit and credit cards are, then prepaid cards appear to be a win-win for folks who need to get a grip on their finances and stop spending money they don’t have.
Prepaid Debit Cards: The Cons
But then there are the fees—and lots of them.
The California Reinvestment Coalition (CRC) is a nonprofit organization that advocates for fair and equal access to financial services for California’s low income communities and communities of color. The organization’s primary concern with prepaid cards is the general lack of regulation and transparency surrounding them.
“Unlike money in bank accounts [that is] spent through debit cards, money loaded on a prepaid card is not required to be insured by the FDIC,” says Sean Coffey, the CRC’s media and development coordinator. “Prepaid cards are also not required to provide the same protections against theft or fraud as bank-issued debit cards…which means a person can simply lose all the money loaded on her card if the card is stolen, even if she reports the theft right away.”
Additionally, prepaid cards are not subject to the same fee limits imposed on debit and credit card transactions, adds Coffey, which means that prepaid card sellers stand to make a fortune not only from the fees charged to customers, but also those that are paid by merchants who accept payment through the cards. And the fees can be steep. Customers can be charged a monthly maintenance fee, an ATM fee if money is withdrawn from an out-of-network teller, a load fee to add more money to the card and even a fee just to check the card’s balance.
Coffey and others worry that prepaid card sellers are engaging in behavior that preys on low-income consumers who are unable to maintain traditional bank accounts. That may or may not be accurate, but ultimately, being armed with knowledge about the product is the only way individuals can stay protected and avoid being taken to the bank.