How are prepaid debit cards different from checking accounts?

Many people who can't or don't want to open regular bank accounts rely on prepaid debit cards as their primary way of making and receiving payments. So what are they?

Gene J. Puskar/AP/File
A person inserts a debit card into an ATM machine in Pittsburgh (Jan 5, 2013).

In 2015, Americans loaded over $76 billion onto prepaid debit cards, using them to receive deposits, make purchases and pay bills. Prepaid debit cards —also called general purpose reloadable (GPR) cards —are a simple alternative to traditional checking accounts. Many people who can't or don't want to open regular bank accounts rely on prepaid debit cards as their primary way of making and receiving payments. So what's the difference between using a prepaid card and opening a checking account?

Prepaid Cards Are Easier to Obtain

Opening a prepaid card and applying for a bank account both require important personal information, including your Social Security number and address. However, banks take the extra step of screening new applicants with credit reporting agencies like ChexSystems to find out whether they have a record of bad banking habits. Because prepaid debit cards do not run such checks, it may be easier for people who have had prior problems with a bank to open a prepaid card rather than a checking account.

Prepaid Cards Have Lower Cash Deposit and Withdrawal Limits

Prepaid cards may limit the amount of cash you can load. For example, the Bluebird Card from American Express allows no more than $1,999 in daily cash deposits. Depending on which prepaid debit card you look at, you'll find daily, monthly or even yearly maximums on how much you can load onto the card. By contrast, a bank usually won't restrict the amount of cash you can deposit in your own checking account.

However, checking accounts and prepaid cards are more similar in their rules about cash withdrawals. Both will limit the amount of cash you can withdraw each day from an ATM, with prepaid cards generally imposing stricter limits than the debit cards that come with checking accounts. Most importantly, prepaid cards may sometimes put a limit on how much cash you can withdraw in person as well. Banks, on the other hand, will almost never prevent you from withdrawing some or all of your money if you visit the bank in person.

Prepaid Cards Don't Allow Overdrafts

Traditional checking accounts often come with the option to permit overdrafts: the bank covers a charge greater than the available balance, for a fee of around $35 per overdraft. With prepaid debit cards, the bank will simply decline any charges that exceed the amount loaded on the card. While this can be inconvenient, overdraft fees represent a significant expense for checking account-holders, so people who have trouble tracking their balance may actually benefit. Prepaid cardholders don't need to worry about paying overdraft fees if they happen to overspend —simply because they can't.

This limitation can help provide a safe learning environment for teenagers to develop good financial habits. Most major banks now offer reloadable prepaid debit cards, and many of those allow you to link to regular checking accounts for easy transfers and management. Through this feature, parents with regular bank accounts can set up periodic transfers to their children's prepaid debit cards, letting them learn how to use a card while keeping their main balance safe from any excessive charges.

Prepaid Cards Are Not As Clearly Regulated

Though prepaid card companies currently provide customer protections that are similar to the deposit insurance you'll find with bank accounts, the fact remains that these protections are determined by card companies, with no federal rules governing the way prepaid deposits are covered. This situation is likely to change as the number of prepaid debit card users grows, with the Consumer Finance Protection Bureau (CFPB) proposing new rules for the prepaid card industry in October 2016.

Currently, the deposit coverage for prepaid cards relies on what is called pass-through insurance. When a customer loads money onto a prepaid card, the company deposits that money in a custodial account at an FDIC-insured bank. The funds in this account are insured up to the standard amount per customer. However, prepaid debit cards do not guarantee loaded funds until the funds actually move into the account. This means that until the company completes the transfer of your funds —which can take up to three days —they are not insured.

While deposit insurance is unlikely to become an issue with larger and more stable prepaid companies, the industry is not yet as secure as traditional banking. In late 2015, a technical glitch left thousands of RushCard customers locked out of their accounts for weeks, exposing them to late fees on bills and even threats of eviction from unpaid landlords. Given the possibility of such incidents, it may be safest to use a prepaid card alongside a traditional savings account with enough money to cover a few months of expenses.

This story originally appeared on ValuePenguin.

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