Prepaid Debit Cards: With all the Scams, are They Worth It?

New scams involving prepaid debit cards are making headlines: Fake loan modification schemes. Fraudsters posing as Internal Revenue Service officials demanding immediate tax payments. Hacking scams involving phony legal fines.

So how safe are prepaid debit cards, and are they even worth keeping in your wallet?

"With any new technology or payment process, as growth explodes, people take advantage of that growth," says Doug Johnson, vice president of risk management policy with the American Bankers Association.

Prepaid cards have become particularly popular among the 68 million Americans who, according to the FDIC, lack full access to banking services. Because you generally don't need to undergo a credit check to get a prepaid card, they're useful if you have no credit score or a spotty credit record. Users can buy general purpose prepaid cards at a host of merchants and use them at stores, ATMs or online, for monthly fees of about $5.

"For people who don't have a bank account or access to regular credit, that's their way of accessing electronic money. It helps bridge the digital divide," says Ben Jackson, senior analyst of prepaid advisory service with Mercator Advisory Group.

But fraudsters are drawn to the cards because they provide easy access to cash outside the scrutiny of the banking system. Criminals posing as legitimate creditors may ask you to purchase a prepaid card, or a reload card for replenishing your prepaid account, and give them the details about the card and PIN. With those details, they can withdraw the cash on the card.

For example, you might get a call from someone claiming to be from your utility company, threatening to turn off your power unless you send immediate payment via a GreenDot MoneyPak. The call is not from your utility company, and the fraudster makes off with your cash.

Prepaid fraud surges A study last year by Mercator found prepaid debit card usage and fraud skyrocketed between 2009 and 2011. Prepaid card usage jumped 120%, to total $83.6 billion in transactions. At the same time, fraud soared 183%, to reach $51 million.

Those numbers primarily include Visa and MasterCard branded cards. They don't include cards issued by American Express or Discover, gift cards, or government electronic benefit transfer cards.

As prepaid debit card usage jumped, the use of traditional debit cards also rose 31%, to $1.82 trillion, while fraud rose just 3%, to $1.33 billion.

Prepaid card issuers continue to put new safeguards in place to protect users, but "it's like a game of Whac-a-Mole," Jackson says. As one type of fraud comes under scrutiny from card issuers and law enforcement, a new one pops up.

One recent fraud involves scammers claiming to be IRS representatives. They call individuals, demanding immediate payment of taxes with a prepaid debit card or wire transfer. So far thousands of victims have lost more than $1 million in the scam.

The scammers often target recent immigrants, threatening to deport or arrest them, revoke their driver's licenses or have their utilities shut off, according to the IRS.

Other common scams involving fraudsters include:

Hackers hijacking personal computers with a screen warning that federal law violations have occurred. The fraudsters demand victims use prepaid cards to pay a fine to get their computers unlocked.
A fake firm offers homeowners a loan modification. Victims are told to stop making mortgage payments, and instead send money on prepaid cards to the fraudsters to cover processing fees and closing costs. Victims fall behind on their mortgages and the fraudsters are never heard from again.

One tax-time threat involves fraudsters filing fake tax returns in someone else's name, and requesting the refund be loaded on a prepaid debit card. Between 2011 and November 2013, the IRS stopped more than 14 million suspicious returns and more than $50 billion in fraudulent refunds, yet countless others have slipped through the cracks. Those who file fraudulent tax returns will use the victim's Social Security number and other personal information, and then ask for the refunds via prepaid debit cards.

In other instances, thieves tamper with prepaid debit card packaging and steal card information. When a consumer loads funds on the card, the crooks spend the money before the legitimate customer can.

Anti-fraud response

Law enforcement, government officials and card issuers are working to ramp up their defenses. "A lot of work is being done to make sure prepaid cards are not being used nefariously," Jackson says.

In one case, a card issuer stopped sending prepaid cards after hundreds of requests poured in from a 10-unit apartment building, Jackson says. In some cases, the IRS is holding some tax refunds longer to make sure they're going to the right people.

Some issuers are submitting prepaid debit card applicant information to a database to see if individuals are trying to obtain a multitude of cards, says Terry Maher, corporate counsel to the Network Branded Prepaid Card Association.

Issuers are also working to prevent identity theft by asking more questions when someone requests a card, such as what address they lived at as a child, Maher says. The answer can be compared with information supplied by data brokers.

Card user behavior is being monitored, too. For instance, if money is loaded from multiple locations and quickly withdrawn, that's a red flag.

The fact that most cards are purchased at retailers, check cashing locations and online, rather than at banks, complicates policing efforts. At the retail level, issuers are using more secure packaging so thieves can't steal the information from cards sold in stores. But because the cards make it easier for the unbanked to purchase goods and services, "we have to walk a fine line between making it more difficult to obtain a card and losing the unbanked," Maher says.

Susan Grant, director of consumer protection at the Consumer Federation of America, says that prepaid cards are more than an alternative for people who don't qualify for mainstream banking. Prepaid debit can also be a budgeting tool for those who don't want to carry cash, but want to avoid the overspending that can occur with other payments.

"They are not like checking accounts that you can overdraw or credit cards where you'll be socked for interest if you can't pay your bill off in full," Grant says.

And an increasing number of employers and government agencies are using them to pay employees or benefit recipients.

Maher says Milennials in particular use them to make online purchases. His three adult children have gone that route after all three had their checking accounts drained after using their bank debit cards to shop online.

Legal protection in flux

Prepaid debit cards lack the consumer protections that apply to bank account-linked debit cards. For lost or stolen bank debit cards, federal law limits your liability to $50 if you report the loss within two days. Prepaid debit cards, except for those issued by the government or payroll employers, don't have that protection under law, although some issuers may provide loss protection in their contracts. The U.S. Consumer Financial Protection Bureau is considering rules that would extend protections to prepaid debit, including limits on fraud liability and the right to dispute unauthorized charges.

While anyone can become a fraud victim, many of the scams target senior citizens or those with low incomes, Jackson says. "They might be less financially sophisticated and might be easier to take advantage of."

And those on fixed incomes or with lower incomes "tend to get hurt a little more" because they lack a financial cushion if they fall prey to a scam, he says. "It's a lot tougher for those people to recover."