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.   

Comments

[Allan]

If the market will bear a 80% APR, have at it. We are a free market society.

I am not against high interest rates. I am against high interest rates masquerading as something else. I might not think this is the card for me, but someone else might.

Here is something I do not understand. If a credit card company says: I will give you $250 of credit a month if you put $250 down and pay me, say 20% interest, why would it need more money? Perhaps there would be a annual fee ($50?) to take care of administrative costs. I would think that there would be money in this and the credit card company would not need to gouge. After all, the company will lose nothing. It can pay the credit down with the deposit. So, for taking no risk, the company gets all the interest plus it gets interest on the deposit.

I am not saying that First Premier should do this. What I am saying is that, in our free market, one would think that there would be some company willing to take no risk to make a guaranteed profit.

Maybe not.

[Joe S.]

Allan,
If you want a free market, move to Russia, where everything can be bought and sold.

Still here? A working market economy--like ours--is NEVER completely free. It has all kinds of rules, which restrict the options of market participants. You can't refuse to perform on a contract without legal consequences, for instance. (Except when you can.) If you own the only store in town, you can't refuse to sell food to somebody, because it amuses you to watch them die of starvation. You can't make any representation about your products that you want. Etc.

[Richard Isacoff]

Back when the "APR" first had to be disclosed in bold type, standing out from all other disclosure material, the change was heralded as the age of Consumer Protection and Full Disclosure. The "APR" computaion is so misleading that not only do credit cards get to disguise the true cost of borrowing but the same applies to mortgage lenders. The so-called TILA documents could be called the "No-Truth in Lending" Dislosure. The same holds true for consumer card compliance meterial. For whatever reason (campaign contributions and effective lobbying efforts) Congress never seems to draft a "tight" bill that would end the misrepresentation. We need, but will not get, legislation that allows consumers to bring actions on their own, that have strong penalties for misleading information, false advertising, and statements that do not contain ALL of an account's financial information (interest rate, all fees annualized, the effective cost of credit as it changes each month). Just a dream but...

[Mike Dillon]

....but a very well stated and accurate dream, Attorney Isacoff. If you aren't already familiar, you may want to take a look at Denise Richardson and GiveMeBackMyCredit.com. I believe that you two would have much to discuss... ;)

[Jane]

And yet there are thousands of people who will gladly take this 79% apr just to have some credit history.

[mt]

To the extent one finds the practice recited in this post socially problematic, it just illustrates why we should dispense with the ever more elaborate disclosure and regulatory apparatus that has been promoted by the Democratic leadership and go with a simple national usury law instead, recognizing that it would reduce credit to weaker consumers drastically but recognizing also that, in the long run, that is the lesser of two evils.

[Adam Levitin]

My point here wasn't to rail against a 79.9% APR. It was just to point out that 79.9% is in the neighborhood (or even less) than people have already been paying to use a First Premier card. Whether 79.9% APR an unconscionable rate is another issue.

First Premier's clientele is super subprime. But even prime credit card users might be surprised at the effective APR On their cards. If so, that tells us something very important--the form of the pricing effects its perception and, perhaps, elasticity.

[Martin, the Netherlands]

Slightly off-topic, perhaps, but I hope somebody can help me out. I understand that having a credit history is very important in the U.S.. You need a credit history to obtain a credit card, but you can only obtain a credit card when you have a credit history. But how do you get started? Paying 80% interest seems an expensive way...;)

[Credit Repair]

Adam, you bring up a good point and one I don't think people realize.. they have been paying the equivalent in fees. When they get a $250 credit line that comes with $230 in fees... But many consumers are stuck accepting this to begin to rebuild their credit. Hard place to be in.

[C wayne Kern]

If everyone thinks first premier is ruthless, check this card i have out as well.First Bank of Delaware A.K.A continental Finance.With this card I have a $ 18.00 dollar a month maintenance fee !19.9% interest rate ,a $50.00 annual fee and & $25.00 credit increase fee twice a year.That is a total of $ 316.oo a year even if i carry a Zero balance.Unfortunnately it is my oldest account and i am scared to close it.

[Jeremy]

Hi Martin,

For my weekly column on credit scoring (link included below), I addressed a reader's question about how new arrivals to the U.S. can build a credit history. You may find it informative.

Thanks,
Jeremy