Editorial Policy

CFPB Decision Could Hit Subprime Borrowers Hard

Marcia Frellick

April 17, 2012

For consumer advocates, the government’s financial watchdog agency has been a valued ally in protecting cardholders from exorbitant credit card fees.

That’s why some advocates were disappointed on April 12 when the Consumer Financial Protection Bureau (CFPB) backed away from imposing caps on the fees banks sometimes charge before a card is opened. This move, advocates worry, could leave customers with poor credit in a vulnerable position.

Loophole closed, then reopenedTh_fee-harvester-cards
The controversy stems from a loophole in the Credit CARD Act of 2009 that regulates what the industry calls fee-harvester cards — high-fee, low-limit cards that are often issued to those with poor credit. The CARD Act stated that banks could charge only up to 25 percent of the designated credit limit in fees in the first year after the card was opened. However, it mentioned nothing about the fees charged before the card was opened — such as application fees, activation fees and processing fees.

Hit by the increased regulation of the CARD Act, some banks began using these up-front fees to make up for the risk of taking on subprime borrowers. In 2011, for example, First Premier Bank began charging a $95 “processing fee” as well as a $75 annual fee, for a credit limit of $300 ($225 after the annual fee was subtracted).

That led the Federal Reserve to step in and close a loophole, specifying that application and activation fees assessed before an account is opened counted toward the 25 percent first-year cap. First Premier fought back in federal court, arguing that the Fed had overstepped its bounds and that the bank was losing millions.

The court sided with First Premier, and the cap was put on hold. The CFPB decided to take up the cause of imposing caps on initial fees but then retreated last week, effectively reopening the loophole the Fed closed.

And that has set off a flurry of complaints from consumer advocates. Four national consumer groups joined together to issue a response.

“Charging $170 for a credit card with available credit of $225 is exactly the sort of abuse that the fee-harvester rule should prohibit,” stated Chi Chi Wu, National Consumer Law Center staff attorney. “The CFPB should not back down in protecting consumers from this sort of chicanery.”

Subprime borrowers hurt the most
So where does the CFPB’s decision leave consumers? Without the cap, banks can charge whatever they like for application, activation and processing fees, which can often reach $100 or more. That’s a good chunk of change, considering that subprime borrowers are often given credit limits below $1,000 — and that many of them aren’t in the position to shop around for a better deal.

The CFPB’s retreat has therefore drawn backlash from consumer advocates who say such fees could be one more deterrent for subprime borrowers who want to enter the financial mainstream. Borrowers with poor credit histories are often targets for higher fees because of the risk associated with lending to them.

“Although the fees are often extremely profitable for lenders, they can be an insurmountable hurdle for people looking to leave the exploitation of the fringe economy populated by check cashing outlets and payday lenders,” says Stephen Stetson, policy analyst for the Arise Citizens’ Policy Project, a nonprofit advocacy group for low-income people in Alabama.

Some consumer advocates are saying the CFPB has let down the very people they are charged with protecting. The CFPB opened for business in July 2011 to help keep consumers from paying too much for loans and from cards with hidden fees or other traps.

“The CFPB was created to protect consumers,” said Ed Mierzwinski, consumer program director for U.S. PIRG (the federation of state Public Interest Research Groups), in the consumer advocates’ statement. “And the best way to do that is to defend the CARD Act regulations when predatory lenders try to chop it back.”

Finding the silver lining
As for why the CFPB would back off from capping fees, the agency isn’t commenting beyond its published rules, in which it acknowledges that its decision may cost some consumers more and allow banks to charge higher fees.

Some industry experts say it may show the year-old agency is picking its battles.

“The hope is that they are keeping their powder dry and spending their limited political capital where it is likely to be most successful and result in rules that benefit low-income consumers,” Stetson says. “That is, after all, why they were created.”

Nessa Feddis, a spokeswoman for the American Bankers Association, says neglecting to cap up-front fees won’t affect the majority of cardholders. That’s because most banks don’t impose the exorbitant fees that were or could have been affected by the rule.

Joe Ridout with Consumer Action in San Francisco agrees.

“This is a fringe product offered by [First Premier Bank], which is effectively being allowed to thumb its nose at federal rules prohibiting excessive upfront fees,” he says.

Ridout says First Premier is an outlier in the industry. The bank made headlines in 2010 when it issued a credit card with a 79.9 percent APR.

Still, Consumer Action is concerned that the CFPB proposal could strip many vulnerable consumers of the protections that both Congress and the Federal Reserve intended to give them, Ridout says.

Options for those hit hardest
Although the CFPB’s decision might allow some issuers to get away with application and activation fees, people with bad credit have many alternatives to high-fee credit cards, Ridout notes.

He recommends starting with secured cards, which often have fewer hidden fees and which are available through many banks. Secured credit cards are bank credit cards supported by money that you keep in a savings account — as little as $200 for a credit line of that amount. If you can’t pay the amount due, the money comes out of the secured deposit so you can’t rack up debt. That deposit makes banks more likely to extend credit to subprime customers, while the line of credit allows consumers to start building better credit histories.

Consumer Action recently surveyed secured credit cards and found that Capital One requires as little as $49 to secure a $200 line of credit, depending on the applicant’s credit. Four of the surveyed cards had interest rates on purchases below 10 percent.

If you are concerned that up-front fees will hurt you financially, the CFPB is looking for your comments on whether such fees should be included in the 25 percent cap. You can submit comments via Regulations.gov through June 11, before a final decision is made.