Prepaid Plastic Is Creeping Into Credit

When Jim McConnell borrowed $400 and loaded it onto a prepaid card he bought at a local check-cashing store near his home in Urbana, Ohio, he didn't realize he was beginning a cycle of debt that would last for more than a year.

Mr. McConnell, a 47-year-old computer repairman, was required to repay the loan in full in two weeks. But that arrangement still left him short of money. So he would take out a new loan and load those funds onto his card, a process he repeated every two weeks. The result: Fees from the card provider totaled $1,344 by the time he stopped borrowing a year later.

Jason Schneider for The Wall Street Journal

"It was a very expensive loan," Mr. McConnell said.

Prepaid cards are among the fastest-growing types of plastic. U.S. consumers loaded $83.3 billion onto prepaid cards in 2011, a 34% increase over the prior year, according to payment-industry researcher Mercator Advisory Group. The cards were designed to help the less-affluent have better control their finances by allowing them to spend only the preloaded amount.

But as overdraft and other credit-like features have been added to these cards in recent years, some consumers are outspending their means and racking up big debts from the cards, say consumer advocates, who are lobbying regulators to ban the practice.

Several nonbank prepaid card providers and large banks that recently started offering prepaid cards, including Green Dot Corp., GDOT +1.11% J.P. Morgan ChaseJPM +4.23% & Co. and Wells Fargo WFC +2.99% & Co., have steered clear of overdraft or other credit-like features. But a number of players, including Netspend Holdings Inc., NTSP +0.87% the second-largest prepaid card provider behind Green Dot, allow users to take on debt, which can add to the fees they must pay.

Some consumers say they like being able to spend more than they load onto the cards. "I don't find it to be predatory," said Gary Harrison Laburay of Bridgeton, Mo.

But the National Consumer Law Center, the Center for Responsible Lending and the Consumer Federation of America, have joined forces to lobby the Consumer Financial Protection Bureau to prohibit prepaid cards from offering any type of credit.

Banning credit is "the most important step that the CFPB can take to ensure that prepaid cards fulfill their promise," the groups wrote in a July letter to the agency.

"A lot of consumers feel like it's helpful, but what they don't realize is the extent to which they get drawn in," said Lauren Saunders, the managing attorney of the National Consumer Law Center. "The next month they start out behind, and all they've done is add monthly fees."

The CFPB is evaluating the consumer advocates' proposal as part of a broader effort to more-closely regulate prepaid cards. A CFPB spokeswoman declined to comment.

Prepaid card companies say they are providing an important service to some of the 60 million Americans that the Federal Deposit Insurance Corp. estimates aren't fully participating in the traditional banking system.

Ted Saunders, chief executive of Community Choice Financial Inc., a Dublin, Ohio, nonbank retailer of alternative financial products that sold Mr. McConnell his card, said prepaid cards are simply a vehicle people can use to load money borrowed from third parties.

While Community Choice no longer sells cards with such third-party relationships, it does allow customers to spend more than they load onto the cards when they sign up for direct deposit and opt in to overdraft protection.

Mr. Saunders, whose company sells the cards on behalf of Insight Card Services LLC, said the overdraft procedures include safeguards to help prevent consumers from taking on too much debt. Unlike the card that Mr. McConnell used, which charged $3.50 for every $25 loaded onto it, overdraft fees are capped at a flat $36 a month.

"We have nearly zero complaints regarding our overdraft program," said William Smith, Insight's chief executive.

But some industry executives question the practice of permitting users to overdraw their balances. "Prepaid cards were designed to be a safety net," said Steve Streit, chief executive of Green Dot. "Once you start adding overdraft and other types of credit, it becomes a form of debt."

Netspend Holdings Chief Executive Dan Henry said the service helps customers "bridge the gap until their next paycheck."

Safeguards at Netspend include updated balance information that customers receive by text or email each time they make a purchase. There are no fees if they reload the card within 24 hours or overdraw less than $10. Exceeding those limits will result in a $15 fee, but overdrafts are capped at three per month and the total overdraft amount cannot exceed $100.

Netspend says only about 6% of its customers regularly use overdraft and two-thirds of the transactions don't generate any fees for the company.

Mr. Henry said that customers regularly tell him how much they like Netspend's overdraft program. When he learned that the CFPB might prohibit overdrafts on prepaid cards, Netspend emailed customers, urging them to write to the agency.

Joette Ortiz of Denver was one of dozens of Netspend customers who wrote that the agency should leave Netspend's overdraft program alone. "It helps me out in a crunch," she said.

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