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Gift Card Gotchas—America’s most popular holiday gift is fraught with problems

Even with “ho-ho-ho” becoming “whoa-whoa-whoa” for belt-tightening shoppers, gift cards once again are expected to be this holiday season’s top purchase—for the fifth consecutive year.

Two in three shoppers plan to buy gift cards in coming weeks, reports Deloitte’s Annual Holiday Survey of 13,000 consumers. Predicted purchase rates are slightly down: 5.3 cards per shopper, averaging $28 each, compared with last year’s 5.5 cards at $36 each. Still, sales could top $100 billion this year for these plastic presents that always come in the right size (fitting nicely in wallets), the right color (redeemed as green) and the right choice (freedom to buy whatever you want).

But as the song says, you’d better watch out. Gift cards can be fraught with problems.

The traditional mainstay of gift cards has been store-branded cards, also known as “closed-loop” cards, valid for a particular retailer. But with more companies facing a make-or-break holiday season, consider this: “If that retailer goes under, its store-branded gift cards will likely be worthless,” says Michelle Jun, staff attorney for Consumers Union, the advocacy group that publishes Consumer Reports. When a company files for bankruptcy protection, it’s up to the retailer to ask the bankruptcy court to allow it to continue accepting the cards; if that occurs, honoring them is usually a low priority. “Gift card holders have to get in line behind all the secured creditors,” says Jun.

When Sharper res filed for bankruptcy earlier this year, holders were told their already-paid-for gift cards—worth an estimated $20 million—wouldn’t be accepted. The company later agreed to accept them only when consumers spent twice the card’s value in a single purchase. After Bombay Co. filed for bankruptcy, its gift cards fetched only 25 cents on the dollar.

That’s why more shoppers have been turning to the other type of gift card—those issued by banks or credit card companies. Available at stores, online or through financial institutions, they usually have a Visa, MasterCard, American Express or bank logo, and can be used anywhere credit cards are accepted. Some are mall-branded, valid in any store in that shopping center.

These “open-loop” cards offer more flexibility and reduced anxiety about their post-holiday value … but for a price. “Whereas most store gift cards don’t have user fees,” says Evan Johnson of the Office of Consumer Protection for Montgomery County, Md., “virtually all bank-issued gift cards do.” Many bank-issued cards also expire sooner than store cards, as quickly as six months from purchase.

Each year Johnson prepares a comprehensive report on both closed-loop and open-loop gift cards sold across the country; a 2008 report should be released after Thanksgiving. Because of various fees—for activating the cards, processing purchases, dormancy period and/or weekly or monthly maintenance charges—a $25 bank-issued gift card given at Christmas may be worth as little as $5 by the summer, notes consumer advocate Ed Mierzwinski of the U.S. Public Interest Research Group. Why? Store cards are regulated by the state, and 38 states have enacted laws restricting fees, expiration dates and disclosure policies. “But those laws don’t apply to bank-issued gift cards, which are regulated by the federal Office of the Comptroller of the Currency, and it’s not as stringent,” says Mierzwinski.

Other factors to consider if you’re considering gift cards:

• In 2006 the value of unused gift cards was $8 billion. If lost, stolen or destroyed, tough luck, says some issuers. Others charge $15 or more to replace a lost card.

• Gift cards usually cannot be redeemed for cash. When permitted, that’s another fee (generally about $15).

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