Credit card companies started off looking down their noses at prepaid cards. According to Mercator Advisory Group, in 2008, Americans spent only $330 million on prepaid plastic. The research firm expects that figure to reach $552 billion next year. That’s nearly 170,000 percent growth in just four years, assuming that your blogger wasn’t overwhelmed by the number of zeros involved when he was making that calculation. No wonder everyone now wants a piece of the prepaid pie.

Why the growth?

There seem to be three main factors driving that growth:

1. State and federal governments are using prepaid cards to deliver tax rebates, unemployment compensation, disability benefits and so on.
2. Millions of Americans saw their credit scores take massive hits during the recession, leaving them unable to get mainstream credit cards or checking accounts.
3. Partly in response to the forthcoming cap on swipe fees (see Credit card companies likely winners in Senate battle this week), many banks have increased their charges and fees, and watered down their rewards programs, leaving checking accounts and their debit cards looking much less attractive.

Credit card companies and banks play catch-up

Last week, the Forbes website published a blog that explained how important those capped swipe fees are to credit card processors:

Card networks such as Visa and MasterCard have witnessed lost revenues due to declining fees charged per transaction after the Fed’s proposal in December last year to limit the debit card swipe fee at 12 cents per transaction. Prepaid cards can help Visa and MasterCard recover lost revenues as the Fed did not limit the swipe fees for most prepaid cards.

Meanwhile, earlier this week, American Express launched its own prepaid product. In a statement, Dan Schulman, group president of American Express’ Enterprise Growth Group, explained why it might appeal to consumers:

We listened to our Cardmembers and customers who told us that although they enjoyed the benefits of a prepaid card–safer than cash, no impact to their credit, no risk of overdraft–they felt having monthly and other maintenance fees undermined the value of the prepaid card. So the feedback from our Cardmembers really helped make a good product, great. We stripped away the nuisance fees and designed an everyday payment card with superb customer service and benefits.

Prepaid problems

Schulman put his finger squarely on the biggest problem with prepaid cards. They’re effectively unregulated, and don’t have to provide any of the safeguards and protections that proper debit and credit cards do.

Prepaids started off as “distress purchases” for people who had no access to mainstream financial products, and some unscrupulous card issuers saw these consumers as fair game. Those companies loaded their card agreements with hidden and often predatory fees and charges that could cripple the finances of many who were already vulnerable. It’s to be hoped that the entry into this market of ultra-respectable players such as American Express will force out less responsible providers.

Credit cards best

Unless your credit score is so battered that you have no choice, mainstream credit cards are likely to remain your best choice for most transactions. Legally speaking, the protections they must provide against fraud, loss, faulty goods and dodgy merchants are superior to debit cards, let alone prepaids. And, of course, they often come with generous rewards and other perks.

So credit card use is likely to make the best sense for most purchases, always providing you’re not one of those people who can’t resist the temptation of getting into unmanageable debt.

Published 06/17/11 (Modified 07/09/14)