How Federal Reserve Regulation z will Affect sub Prime Lenders

Bad credit cards for people with bad credit proliferate, strongly marketed by sub prime lenders to those desperate to obtain a credit card at any cost. In February 2010 I documented a credit card issued by the sub prime lender First Premier Bank, the smiling face of bad credit. At the time First Premier were issuing an unsecured credit card with a $300 credit limit. They imposed various imaginative charges which included a $95 annual processing fee and a $75 annual fee. This left an available credit limit of $130 but other charges ate into most of that. Effectively some card holders were left with just $50 of available credit.

Quite why anyone would be willing to pay so much in fees to obtain a credit card is beyond belief, but to be fair to the hapless first Premier customers most of the fees were hidden in the small print. In addition those with bad credit are typically bad payers and realise that they will be charged far more to open a credit card as they have few other options if they are determined to continue using credit.

Later on in 2010 the Credit Card Reform Act of 2009 introduced changes. One of them was directly targeted at this usurious practice of applying outrageous charges. The amendments called for fees to be no more than 25% of the available credit limit. Thus First Premier Bank would be limited to charging no more than $75 in fees on a card with a $300 limit, leaving the card holder a generous credit limit of $225. First Premiers reaction was to introduce a secured credit card.

Their secured card offered a $200 credit limit and required a $200 security deposit. The fees applied to the account were exactly $50 thus abiding by the new amendments. However First Premier then returned to offering unsecured credit cards having spotted a loop hole in the amendment by interpreting the law in a way to suit them.

The latest card they offered charged upfront fees of exactly 25% of the credit limit but the bank then imposed a $75 application fee on top of the other charges. Their defence was the fee was applied before the credit card was opened so did not count towards part of the fees to use the card. They then slapped on an interest rate of 59.9% and began marketing a card with a 79.9% APR.

The bank’s attitude is take it or leave it when it comes to the interest rates, and points out that anyone who pays down their balance in full each month will pay no interest at all. They justify their charges by pointing out the very high risk of lending to those with bad credit who are typically bad payers. The card which was sent out as a mailing offer carrying the 79.9% APR and has had a 2% take up rate as those with bad credit rush to swoop up such a good deal.

It was perfectly obvious that sub prime lenders were flouting the law by applying application fees which together with the other fees meant that they were skirting round the 25% law. The Federal Reserve has moved to address this issue by introducing a new Regulation Z to the Credit Card Reform Act. The new amendment stipulates that total charges applied cannot exceed 25% of the available credit limit and that fees imposed before the card is opened are considered part of this crucial 25%. The issue of the bank charging half of any credit limit increase as an additional fee is not addressed.

Without the high fees the sub prime lenders were raking in they say that there business as bad credit lenders may not be sustainable due to the high risk nature of their customers and the high levels of default. It is hardly surprising that customers default when they understand how much of their balance is in fact slippery charges.

The high APR of 79.9% actually represents a better deal to customers than high charges, but only if they pay their balance in full, something which bad credit customers are not famous for doing. It will be interesting to note what new tricks sub prime lenders can think up to work around Regulation Z and still retain high profits. They must surely be hoping that their customers never pay the full balance as a 79.9% APR should prove more than lucrative.

My expectation is that as the high interest rate has not deterred applicants who are queuing up to be customers that the bank will simply increase the APR to new customers. The question remains will they stay on this side of 100%.

First Premier Bank is by no means the only sub prime lender engaging in such practices, but they do command the most market visibility. Watch this space to see how exactly sub prime lenders react to Regulation Z as something creative may well be in store.

Source: The Federal Reserve.