APR Shocks Many, but Issuer Says They Are Pricing for the Risk
If you have bad credit in the new era of credit card regulation, be prepared to pay -- dearly -- for the privilege of using credit. That's the message underlying recent credit card offers that feature jaw-dropping interest rates of up to 79.9 percent.
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The sky-high rates may be a sign of things to come in the market for so-called subprime credit cards as issuers who lend to the riskiest of borrowers try to figure out how to stay in business and comply with the new credit card reform law.
"We need to price our product based on the risk associated with this market and allow the customer to make the decision whether they want the product or not," according to a statement issued by Miles Beacom, CEO of Premier Bankcard, the South Dakota credit card marketer that mailed test offers in September and October featuring 79.9 percent and 59.9 percent annual percentage rates (APRs) on cards with $300 credit limits. Premier markets credit cards issued by First Premier Bank.
Yes, It's Legal
A national bank charging 79.9 percent interest on a credit card is legal -- as long as the issuer fully discloses the terms as required by the federal Truth in Lending Act. Still, the high rate has been met with shock across the country because it is so much higher than prevailing APRs and penatly interest rates. The CreditCards.com Weekly Rate report national average for bad credit credit cards was 14.15 percent on Feb. 12.
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The high interest rate offers may add urgency to an ongoing debate on Capitol Hill over reinstituting nationwide usury rates that cap credit card interest rates. On Dec. 11, a lawmaker introduced a bill in the U.S. House of Representatives to cap credit card rates at 16 percent -- the latest attempt among several in recent years to limit rates. The powerful and well-financed banking lobby has successfully quashed those efforts.
Credit counselors warn consumers to be sure they read the fine print of these new offers and seek advice about other options before signing up for the cards.
"Anyone who feels they have no choice but to get one of these should get help from a credit counselor," advises Sandy Shore, a counselor with Novadebt, a New Jersey-based consumer credit counseling agency. "There are other alternatives, like a debit card or even a secured card. The counselor can give the consumer other ways to reestablish their credit, depending on their circumstances."
Law Limits Upfront Fees
New restrictions in the Credit CARD Act of 2009 limit the upfront fees credit card issuers can charge on subprime accounts. The low-credit, high-cost cards, known as fee harvesting credit cards, are issued to people with bad credit or no credit history and feature credit limits of $500 or less. Issuers typically charge a slew of fees at the outset to compensate for the risk of lending to people with poor repayment histories. Starting Feb. 22, 2010, the law will limit upfront fees to no more than 25 percent of the available credit on the account.
As a result, subprime credit card marketers are testing the waters with offers that essentially shift the pricing on their products from upfront fees to high interest rates.
The First Premier card's test offer featured a $75 upfront fee -- exactly 25 percent of the card's credit limit, as the new law mandates. "Because of the new regulations that limit the fees on a credit card to 25 percent of a credit card's line, we will need to shift the premium from upfront fees on risk to the interest rate," Beacom says. "We have to be able to price the product to offset the risk."
In December, the bank's regular Gold card, as advertised on its Web site, include a 9.9 percent APR and the following upfront fees: $29 account setup fee, $95 one-time program fee, $48 annual fee and a $7 monthly servicing fee.
"There's 70 million people out there who have been identified with problem credit," says Beacom, adding those are people with FICO scores lower than 640. "These are people who have had problems with their credit in the past."
He likened people with bad credit to bad automobile drivers who must pay higher auto insurance premiums if they want to continue driving. "These are people who have had those same accidents or speeding tickets with their credit."
He adds: "It's going to be very difficult for these individuals to obtain credit after February."
Prior to the credit crunch, a subprime borrower might take eight to 16 months to build a good enough credit record to qualify for lower interest rates on prime cards. Today, however, because the prime lenders have dramatically tightenend their credit standards, it could take 16 to 24 months or longer to build their credit.
Competitive Market Changes
In addition to Premier, the Nevada-based Credit One Bank has also mailed out offers featuring different fee structures, according to Andrew Davidson, senior vice president of Mintel Comperemedia, a Chicago direct-mail research consulting firm. Mintel is tracking how credit card offers are changing in light of the credit card law restrictions. "The indication here is that the subprime issuers are looking at ways to work within the new law," Davidson says. "Some suggest they will stop operating in that space, but the reality is there are always going to be people who need to establish credit and rebuild their credit."
He notes that while many credit card issuers scaled back direct mail card offers during the recession, "First Premier has consistently been mailing during the downturn." The reason: Demand is high among people with bad credit. "If they can work around these laws so that they can have a business model that works, they can continue to have a successful operation," Davidson adds.
One of First Premier's competitors in the subprime credit card market, CompuCredit, apparently could not find a model that worked for them while complying with the new law. Under fire from consumer advocates, facing lawsuits and mounting losses, CompuCredit decided to stop marketing the high-fee cards to bad-credit consumers.
Credit One's Platinum Visa card offer mailed in August 2009 featured a 23.9 percent APR and a range of annual fees that were card law compliant, that is, no more than 25 percent of the credit limit on the card, according to Mintel.
An spokeswoman for HSBC, another marketer of subprime cards, said it has no plans for testing. Premier's Beacom says the new regulations may make it impossible for subprime issuers to continue to make money in that high-risk niche market.
"The cost of funding for these products is very difficult these days," he says, noting that his competitors are also testing different product offerings. "One, many or maybe all" of the subprime issuers could go out of business, he says.
Beacom says it's too early to tell if the 79.9 percent card offers will last. It normally takes them nine to 12 months to analyze the results of a test product.
Customers who sign up for the high-interest card and want to back out can get full refunds and close the accounts, Beacom says.
"From our initial research we know that 83 percent of the people who accepted the offer are fully aware of the interest rate they are receiving and the purpose of the credit card to help re-establish credit. If anyone accepts the offer and didn't fully understand it or no longer wants it they can take advantage of our full refund of fees policy."
Response to 79.9% Offer 'Phenomenal'
Has First Premier gotten any takers on the 79.9 percent cards? Beacom called the response "phenomenal," adding 2 percent of people receiving the offers have applied for the cards. Their normal response rates is 1 percent to 1.2 percent, he says. "It's double what our normal product was."
Shore, the New Jersey credit counselor, urged consumers not to jump at the first high-interest offer they receive. "I would caution anyone who is considering a card like this to wait. Other credit card issuers will be adjusting their products and there may be better alternatives coming out," Shore says.
"No one should be shocked at the interest rate on [the First Premier] card," Shore notes. "These cards are being marketed to consumers with very poor credit. The APR is actually much lower than the old subprime cards because the fees are much less."
In other words, when you added up all the fees on the old cards, they're the dollar equivalent of a huge interest rate on the amount borrowed. (For example, $250 in fees on a $300 credit limit would amount to an 83 percent interest rate.)
"If someone wants to take a chance on a card like this, they should use it only as a convenience and pay the whole thing off when the bill comes," Shore adds. "Many consumers who have credit that poor do not have good credit habits and are likely to carry balances."
Beacom from Premier says the astronomic interest rate will only affect revolvers -- people who do not pay their entire balances off each month. "People pay it off every month, they pay no interest," he adds.
Those getting the offer have a choice, Beacom says.
"If everything is fully disclosed, if they want it fine, if they don't want it fine," he adds."People should be able to make that decision rather than the government cutting off access and saying they know best."
"Our goal is really to keep these lines controlled because these are people who have had problems in the past," Beacom says. "It's really to help build up the discipline without them getting into credit trouble again."
"Whether it works or not, time will tell," he adds.