New Credit Card Tricks, Traps, and 79.9% APRs
The card industry is at it again, devising new tricks and traps to disguise the cost of its products and avoid price competition. Unfortunately, this was exactly what I predicted in the wake of the Credit CARD Act. I was a vocal supporter of the Credit CARD Act, but I also viewed it as a missed opportunity. Congress focused on prohibiting particular abusive credit card practices, but left the door wide open for the card industry to put all of its ingenuity to work devising new substitute practices. Far better if Congress had taken up a regulatory model that permitted card issuers to charge only certain specified types of fees (at whatever level).
Now, even before most of the Credit CARD Act's provisions have gone effective, a new report from the Center for Responsible Lending finds that the card industry has already invented a new bunch of tricks and traps. (I'm still waiting to see an issuer implement my personal candidate--the "high risk transaction security fee"--which could be applied to pretty much any transaction the issuer wants to deem high risk.)
One thing the Credit CARD Act did quite effectively, however, was clamp down on so-called "Fee Harvester" cards-ultra subprime cards that charged extremely high upfront fees, but offered minimal lines of credit. The Credit CARD Act limits upfront fees to 25% of the line of credit, effective in February 2010.
It's interesting to see how fee harvester card issuers are responding. Many assumed that they would simply be out of business. I'm not so sure that's the case. A recent news story about South Dakota-based First Premier Bank, NA, perhaps the king of fee harvester companies, shows how the card industry is adapting. Currently, a First Premier card bears a 9.9% purchase APR, a $250 line of credit and at least $256 in fees in the first year, $179 of which are immediately applied. The $256 is divided among four different fees.
First Premier is apparently now using direct mailing offers to test a new product that conforms with the Credit CARD Act. This new card has $75 in fees and a $300 credit line, but a 79.9% purchase APR. Yes, you read that correctly. 79.9%. Now 79.9% APR looks pretty shocking, but it turns out that the new card is actually be cheaper than the old First Premier card.
To compare the costs of different credit cads, we need to put all fees and interest into a single unit. This is the "effective APR". That is the best measure of the cost of a card. The effective APR is only disclosed on card billing statements after the fact because it includes various contingent fees; card advertisements feature stated APRs, but the effective APR is almost always higher.) So let's compare effective APRs for the old and new First Premier cards. Let's assume that the entire line is used for the entire year (probably a reasonable assumption with a Fee Harvester card). Let's also assume that no other penalty interest rates or other fees apply (as they likely would). For simplicity, we'll also pretend that all the fees are paid upfront (they're not), and that there's no compounding of interest. I'm also going to assume that there aren't any other fees on the new card that have been missed in the reporting. (I haven't seen a TILA disclosure for the new one, but if anyone has it, please send me a copy.)
The effective APR for the old First Premier card is 112.3%, as it will cost $280.75 to gain access to a $250 line of credit for a year. The effective APR on the new First Premier card is 104.9%, as it will cost $314.70 to gain access to a $300 line of credit for a year. The new card with the 79.9% stated purchase APR isn't cheap, but it's a better deal than the 112.3% on the old First Premier card. And, more importantly, there are less sunk costs in opening the new card for the consumer, so the switching costs are lower.
There are a couple of important points here. First, the 79.9% APR on the new First Premier Card is not evidence that the Credit CARD Act is resulting in higher costs of credit. If anything, it is consistent with the Credit CARD Act making some headway in forcing meaningful price disclosure and pushing down credit costs. (I don't think the Credit CARD Act will be particularly effective this way, but nonetheless, it's worth noting.)
Second, it serves as a reminder that presentation matters in disclosure. Fees and interest are basically interchangeable. (See Smiley v. Citibank). The $181 difference in fee income over a year between the old and new cards is just about equal to 79.9% of $225, which is the effective line of credit ($225=$300 line minus $75 in fees) on the new card. Instead of $256 divided among 4 different fees, all under $100, the consumer is confronted with an eye popping 79.9% APR in big, bold font in the Schumer box. That might have a cautionary effect on consumers, even thought First Premier clients usually aren't especially concerned about costs.
We might be shocked by a 79.9% APR, but that's an awful lot closer to the true cost of using a First Premier card than the old 9.9% APR. And if we're shocked at what we pay for credit, that should tell us just how good the card industry has been in disguising costs for all these years.