New ways to pay

At the checkout, should you use credit, debit, or cell phone?

Last reviewed: September 2011
Google Wallet, paying with your cell phone
No swiping
Google Wallet, expected this summer, will let users pay by tapping their cell phone on a terminal.

What's in your wallet? If you're like the majority of Americans, you're still using cash, checks, and credit and debit cards for your day-to-day purchases, according to a recent nationwide survey by the Consumer Reports National Research Center. But new electronic methods are emerging, and banks and technology companies are jostling for a greater share of the $50 billion a year in fees generated by everyday transactions.

Some of the nation's biggest companies—AT&T, Google, PayPal, and Verizon—and a host of smaller companies are forging partnerships and developing apps that will turn your cell phone into a payment device. But before you chuck your plastic for a flashy new phone, you should know that new payment methods might have hidden costs or fewer consumer protections than traditional ways to pay. And you need to be aware of your liability in the event your cell phone is lost or stolen.

New 'digital wallets'

Some services already allow you to pay for purchases with your cell phone (see Pay with your cell phone), and so-called digital wallet services are hitting the market. Google said in May that it planned to launch its version this summer. Here's how it will work: If you own a Nexus S 4G phone from Sprint, a downloadable Google Wallet app will let you pay for purchases with Citi PayPass-eligible MasterCards or a Google Prepaid Card by tapping the phone on a PayPass terminal.

At least three competing digital wallets are planned for launch later this year and in 2012: from Visa in partnership with more than a dozen banks; Isis, a joint venture of AT&T Mobility, T-Mobile, and Verizon Wireless; and PayPal Mobile's point-of-sale technology.

Despite all the hype surrounding digital wallets, retailers aren't swarming to buy the equipment necessary to link your cell phone to their cash registers. Businesses need to see a dollars-and-cents advantage, "but what's out there now doesn't have a lot of value to merchants," says Avivah Litan, an analyst at Gartner, an information technology research firm.

Consumers don't seem to be clamoring to pay with their phones yet, either. Only 5 percent of survey respondents have used their cell phone to pay for day-to-day purchases in the previous month. Somewhat more use other fairly new forms of payment, including billing to their home or cell phone account (10 percent).

Electronic banking is more widely used. More than 50 million consumers access their accounts online, and 39 million have signed up for mobile banking, which lets them pay bills, transfer funds, and do other transactions by cell phone—including deposit checks by photographing them using the phone's camera. More than 60 percent of our survey respondents have made online electronic payments from their bank account.

Hidden costs

Most of the new electronic payment options are tied to credit and debit cards, so whatever costs you incur in using your plastic will transfer to the new methods. But some costs are completely hidden, so consumers are often unaware of the price of their payment-choice decisions, says Scott Schuh, director of the Consumer Payments Research Center at the Federal Reserve Bank of Boston.

For example, banks have long charged a fee of 1 to 4 percent of the purchase amount, depending on whether debit or credit was used. That fee is levied on retailers, so consumers don't see it up front, but they pay it in higher merchandise prices. "The average household pays $427 a year in transaction fees to card companies and banks that they don't know they're paying," says Mallory Duncan, senior vice president and general counsel for the National Retail Federation.

New Federal Reserve rules that go into effect on Oct. 1 limit fees on debit-card transactions to 21 cents plus 0.05 percent of the value of the purchase. Fees for credit-card payments, which average about 2 percent, were not changed, though merchants can set a $10 minimum on credit-card purchases. Retailers can offer price discounts for cash payment.

Paying by mobile phone won't save you money. Google Wallet merchant transaction fees are the same as those charged on plastic payments, and the same is expected to be true for Visa's digital wallet. Square and PayPal Mobile charge merchants even more than the average big-bank fee, 2.75 and 2.9 percent of the transaction amount, respectively.

Among payment processors we looked at, only Obopay charges consumers (not merchants) an explicit flat 50-cent fee for payments over $10. You can transfer funds to your Obopay account from a bank account at no cost, but if you link a transaction to a debit or credit card, you'll pay a 1.5 percent fee. So on a $100 payment, fees can run from 50 cents to $2.

Prepaid debit cards can be especially costly, whether you use them by themselves or link them to an alternative payment method. Many prepaid debit cards charge fees for activating and maintaining the accounts, and for transactions, balance inquiries, and reloading. A recent study by Consumers Union, the nonprofit publisher of Consumer Reports, of 12 prepaid cards and basic checking accounts at five major banks and two credit unions found that prepaid cards usually cost more for the same services.

About 32 percent of consumers use prepaid debit cards, according to an April Federal Reserve study. Last year, consumers used them for $37 billion in purchases, according to the Network Branded Prepaid Card Association.

Cash is the cheapest way to pay. The transaction cost is essentially zero, and with the new Fed rules, look for—and demand—more discounts for paying green.

Bottom line

Before signing up for a new payment method, read the fine print and check the transaction costs.