Prepaid cards need a makeover

This post comes from Jeanine Skowronski at partner site MainStreet.

By many measures, the prepaid debit card industry is booming. During the past few months, new cards have hit the market, enhancements have been added to existing ones, fees have been reduced and celebrities have entered into partnerships with various companies.

But each new product, feature or face has been accompanied by an equally widening wave of scrutiny, the gist of which is always the same: The cards offer high fees and low incentives to "unbanked" or "uncreditworthy" consumers who shouldn't have to pay for the privilege to spend their own money.

While MainStreet thinks some of the criticism is warranted -- and has dished it out on occasion as well -- we can't help but think the industry has some potential, if only for the opportunity for innovation it affords. (Case in point: What other payment method could get away with doubling as a student ID?)

But in lieu of abolishing all fees -- which isn't likely since they are largely the only way for issuers to turn a profit on the cards -- is there anything providers can do to shake the stigma that's come to be associated with a prepaid card?

MainStreet came up with a few ways the industry could improve its image.

Make the actual cost of the card easier to understand

While the fees driving much of the criticism are generally high, many prepaid providers are good about disclosing them, and fees are usually given a devoted section on many of their websites. The real issue is that these charts and disclosures are so full of clauses and caveats about how the fees are incurred or, more commonly, avoided, it has become very difficult to figure out how much the card is going to actually cost a person to use. As such, it has also become much more difficult to compare one card with another, since the fee structures and their accompanying clauses are rarely the same.

Several card-ranking sites, such as NerdWallet, recently introduced tools that allow consumers to compare prepaid debit cards by specifying how they plan to use them. If a similar tool was provided by the debit card's issuer, transparency may become less of a point of contention. Post continues below.

Continue to add incentives

Criticism of the industry has become so rampant, it's easy to forget some important factors contributing to the sector's growth.

First, the Credit Card Accountability, Responsibility and Disclosure Act, which prohibits companies from issuing credit to anyone under 21 unless the applicant has a stable source of income or a willing co-signer, caused parents to look for alternative plastic payment methods that could help college-bound kids in a jam.

Secondly, the Durbin Amendment to 2010's financial reform legislation excluded prepaid cards from the swipe fee caps that cut into the revenue banks make on traditional debit cards. The Durbin exemption is perhaps more notable here as it gives banks and major issuers the incentive to introduce low-fee prepaid products and fosters competition.

To stand out, many prepaid providers have already added incentives to their existing products. Russell Simmons' RushCard currently gives cardholders the opportunity to earn $2 back for each month they maintain a balance of $500 or more in linked savings accounts, and Mango Financial lets cardholders with direct deposit earn a 6% annual percentage yield on the money in their saving accounts.

Both companies have said they are considering adding other enhancements to their cards. (RushCard is considering alternatives to payday loans and 5% cash-back incentives, while Mango says a rewards program is in the works.) While these features aren't likely to completely eliminate the criticism, they could certainly temper it and lead to new innovations even harder to discount.

Widen their target market …

In many respects, the controversy surrounding prepaid cards isn't driven by what the cards do or don't do -- it's who the cards are being marketed to, which are namely low-income individuals who can't get a credit card or even a bank account in many cases.

Asking folks to pay a fee so they can spend their own money is incendiary on its own -- as evident by the revolt banks endured when they announced plans to impose fees on traditional bank accounts  last year -- so it's only natural that asking people who are struggling financially to pay a similar fee (and then some) will kick the backlash up a notch.

But if providers were to add incentives, as suggested, and actively market these to moderate-income consumers as well, they could come out ahead. After all, debit card rewards programs were killed off by the Durbin Amendment and 5% interest on a savings account is few and far between.

… or bill it as a short-term solution
If a prepaid provider isn't interested in widening its target market, then it might be best to acknowledge the card's limitations. Prepaid offerings don't help consumers build credit and, as such, aren't a viable solution for someone whose main aim is to get on the grid.

Admittedly, many prepaid providers are actively trying to get credit bureaus to accept their data and factor it into credit reports, but until this happens -- and it's an uphill battle -- it needs to be clear that the card isn't a solution to long-term credit problems.

More on MainStreet and MSN Money:

• Meet the man with 50 credit cards
• The best credit union credit cards
• The best low-interest credit cards
• Has Suze Orman lost her cred?
• Why Suze's card won't help you
• Prepaid vs. secured credit cards