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Should You Be Using Your Credit or Debit Card at All?

By Molly McCluskey – Oct 15, 2012 at 2:28PM

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A new suite of prepaid debit cards takes up where other cards left off.

Nearly a year ago, I asked readers if they should be using their credit card more. It was in the midst of the major banks hopping on the swipe-fee bandwagon, where the announced that to recap fees lost by a new cap on what they could charge merchants, they were going to begin imposing fees on customers for using their debit card.

This was an exact reversal from a few years earlier when, faced with massive credit card debt write-off, banks had incentivized customers to use their debit cards by providing them with the same rewards, bonus points, and perks that credit cards had traditionally offered.

Three months ago, I asked readers if they should be using their credit card less, after Visa (V -0.70%) and MasterCard (MA -0.77%) reached a settled in a class action suit regarding price-fixing over swipe fees, in violation of antitrust laws. Under the agreement, MasterCard and Visa paid $7.25 billion, and merchants would be allowed to pass the higher swipe fees they were charged onto customers. However, American Express (AXP -1.83%), which wasn't involved in the lawsuit, has parity agreements with its merchants in 10 states stating that AmEx customers must be charged the same as a MasterCard or Visa customer, which effectively tied the hands of merchants in those states.

Swipe fees generate nearly $40 billion a year for the banks. With debit card swipe fees and credit card swipe fees both getting thrown under the bus in the past year, it's no surprise that banks have gotten creative and found another outlet for this lucrative market: prepaid debit cards.

Not your auntie's prepaid
Prepaid debit cards used to be the thing that your semi-cool aunt used to give on birthdays because cash seemed tacky. They were preloaded with a fixed amount, were purchased for a flat rate of about $4.95 or higher, and had hidden fees for reactivation after lapsed activity, expiration dates, and the like. Customer service with these cards was notorious, and stories of cards that were leakier than a BP oil well abounded. The Credit CARD act of 2009 stripped some of these practices by curtailing expiration dates and eliminating dormancy, inactivity, and service fees for cards less than one year old, unless clearly stated.

But if there's one thing we've seen in the past few years, it's just how determined banks are to make a profit. And $40 billion in swipe fees isn't something that they're going to let go without a fight. Enter the newest incarnation of the prepaid debit card.

Almost like the real thing (whatever the real thing might be)
The bank with the least transparent motives is JPMorgan Chase, (JPM -1.52%), whose Liquid card looks and feels like the debit card checking account customers would be carrying had Chase gotten its way last year. The card has a $4.95 monthly fee that is higher than the $3 monthly fee Chase had proposed last year, while the $2 fee for withdrawals at non-Chase ATMs is lower than the standard $3 for checking account customers, and still lower than the bank's $5 proposed fee, which failed in pilot in May 2011.

In direct contrast is American Express's Bluebird, the reloadable prepaid debt developed in partnership with Walmart (WMT 0.82%). While AmEx's Green Dot and Vanilla prepaid cards both have initiation fees, Bluebird has no activation fee, no minimum balance requirement, and no monthly fee, although a starter kit costs $5.

The card is expected to widen American Express' membership base to include lower-income families. Unlike Chase, which can offer prepaid debit cards in addition to its checking account offerings, American Express' card is designed to offer an alternative to checking accounts, which AmEx doesn't offer.

Only the beginning
While the prepaid debit card industry is still largely unregulated, those days may be ending even as other major banks prepare to roll out new cards. According to the New York Times, the Consumer Financial Protection Bureau will soon be proposing regulations because of "its concerns about high fees and inadequate disclosures."

The "closed loop" prepaid market, those cards that are only redeemable at certain retailers, like restaurant gift cards, etc., reached $299.1 billion in 2011, a growth of 13% from 2010. The "open loop" prepaid market, which includes MasterCard, Visa, and American Express branded products, was $184.1 in 2011, up 24% from 2010, according to the Mercator Advisory Group, which studies the payments industry.

Do you use/give prepaid debit cards? Would they make you switch from credit cards or your checking account? Tell me below.

Molly McCluskey doesn't own shares of any of the companies mentioned. Follow her finance and travel tweets on Twitter @MollyEMcCluskey.

The Motley Fool owns shares of MasterCard. The Fool has created a bear call spread position on American Express. The Fool has on MasterCard. Motley Fool newsletter services have recommended buying shares of Visa. Motley Fool newsletter services have recommended creating a write covered strangle position in American Express. The Motley Fool has a disclosure policy.

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