Credit Card Processing Blog

It didn’t take long at all! Via the Denver Post we learn that college students under the age of 21 have found a way around the recently enacted provision of the new CARD Act, which makes it much harder for them to open credit card accounts. The solution? Find an older student to co-sign for you.

Under the new rules, issuers cannot approve the credit card application of anyone under the age of 21, unless they can prove that they have the means to pay back the debt. If that’s not an option, the youngster would have to find an older co-signer.

Typically, the first co-signer choice would be a parent. Many parents see this as an opportunity to help their youngster build credit history and feel confident enough that the card would be used responsibly. If all goes well, once the kid turns 21, he or she will open their own card and the joint account can be safely closed.

However, there is a different scenario, under which the student runs up the credit line until it gets out of control. This is often a well-founded concern and the problem is that it not only destroys the youngster’s credit history, but it also damages the co-signer’s.

So many parents prefer to provide their kids with safer payment options, including debit cards and prepaid cards. While neither card helps build the child’s credit history, there can be no negative consequences either, as the damage is limited to the deposited amount.

Additionally, as FICO told us, more Americans than ever have sub-prime credit scores, making them unqualified co-signers. In the words of Estevan Torres, a 20-year-old graphic arts student at Metropolitan State College of Denver:

“I don’t have bad credit, but I can’t get a card because my parents have the bad credit,” he says. “For them to co-sign for me makes it guaranteed I won’t get a card, so I’m thinking of asking one of my friends.”

Yet, credit cards have proved irresistible and perhaps the newly imposed limits have added to their allure, forcing students under 21 to get creative. And a solution was promptly discovered. All that was needed was to enlist the help of older students. Some of them reportedly charged a fee for the service.

Now, this is an unfortunate side effect of the new regulations and many co-signers will undoubtedly live to regret their actions, but it is unlikely that the practice will reach epidemic proportions. Moreover, a stricter law would have punished those youngsters who would use credit responsibly. Although flawed, the law does place substantial hurdles for youngsters to open credit cards, without closing the door shut.

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Via CNNMoney.com we learn that N.Y. Sen. Charles Schumer wants to force credit card companies to apply the same underwriting standards they use for issuing regular consumer cards to business credit cards. The recently passed CARD Act has placed a number of restrictions on what issuers can and cannot do regarding interest rates, fees and information disclosure, however the rules apply only to consumer cards.

Under the CARD Act, for example, if a cardholder is late on a payment, interest rates can only be raised if the delinquency is bigger than 60 days, and then only after the issuer has served a notice to its cardholder. Even then, the cardholder can opt not to accept the new interest rate, in which case he or she will have to close the account and repay the outstanding balance on the old rate. The CARD Act also limits the amount of penalty fees to the amount of the violation, but not to exceed $25.

These and other consumer protections do not apply to business cards and Sen. Schumer thinks that credit card companies are taking advantage of this loophole by making it too easy for consumers to get their hands on them. He’s asked Ben Bernanke, the chairman of the Federal Reserve, to do something about it. “I believe that credit card issuers are exploiting this distinction in order to evade the tougher regulations passed by Congress and preserve their ability to profit from unfair and excessive fees,” explained Schumer.

Schumer actually doesn’t want to amend the Act by extending its protections to holders of business cards, but rather to make them harder to obtain. One specific requirement he believes would help achieve this goal is to require issuers to collect Tax IDs from applicants. Currently, business card applications ask for little more than the business’ name, aside from the principal’s personal information. There are known instances of approved business credit card applications when a fictitious corporate name was provided.

Now, it is true that a consumer can open up a business credit card account fairly easily, but is that necessarily a bad thing? These cards are typically used by entrepreneurs and small business owners with limited access to business credit. Many of them do not have a Tax ID, using their social security numbers instead, so it would be difficult to prove that they actually own a business. It is true that credit cards are far from the ideal source of short-term capital, but for the most part entrepreneurs understand that and use it only when there is nothing better available, accepting the associated risks.

Placing additional hurdles in the application process will probably prevent some consumers from opening up business card accounts, but will also make that more difficult for small businesses. Even in the best of times entrepreneurs have plenty of issues to deal with and adding one more is not exactly helpful. Now is certainly not the best of times.

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Credit card companies are pushing hard their small business card offerings, even as they continue to contract their regular loans. Issuers mailed out 47 million business card offers in the first quarter of 2010, an increase of 256 percent from the same period last year, according to research firm Synovate. Three-quarters of all small business applicants for credit cards were approved, according to a report from the Federal Reserve, published in May. At the same time, small business lending has shrunk by $40 billion in the first quarter of 2010 as compared to 2008. Moreover, only a third to half of small businesses were actually approved for a loan or line of credit in 2009. Often, credit card approvals were given by the same banks that previously denied the business a regular loan. Here is the gist of the Fed’s report:

The vast majority of small businesses use personal or small business credit cards. Most small businesses that use cards pay their balance in full each month, but some carry a balance, or borrow, on their credit cards. Small business credit cards differ from personal cards in that they are issued to firms, rather than individual consumers, and are intended to be used for business purposes only. Small business credit cards are also distinct from other types of card products designed for businesses, such as corporate cards, procurement cards, and fleet cards.

As of the end of 2009, 83 percent of small businesses used credit cards; 64 percent used small business cards, and 41 percent used personal cards. Despite the widespread use of credit cards, only a minority of small businesses – 18 percent – reported borrowing on credit cards. About 12 percent of small businesses borrowed on small business cards, and about 12 percent 2 Board of Governors of the Federal Reserve System borrowed on personal cards. In the aggregate, credit card debt represents a very small percentage of total debt held by small business owners to finance their business operations. In 2003, when 24 percent of small businesses reported borrowing on credit cards, credit card debt accounted for just 1.4 percent of all debt held by small businesses and the majority of credit card–borrowing firms reported borrowing less than $5,000 in total on all their credit cards.

It is not all that hard to understand the rationale behind the banks’ lending decision process. On the one hand, credit card interest rates are typically higher than those of regular loans and contracts can be changed much more easily.

The bigger reason for the banks’ eagerness to issue small business credit cards, however, is the fact that they are not covered by the protections of the recently passed CARD Act. Yes, although they look the same on the surface, there are huge differences between business and regular consumer cards.

The CARD Act’s ban on inactivity fees and the $25 cap on late fees, for example, do not apply to small business cards. Nor does the requirement that cardholders get notified prior to a rate increase, of which they can opt out and close their accounts. Additionally, issuers can retroactively raise interest rates on small business cardholders, even if they are only late on a payment by a day. Retroactive fees can now only be applied to consumer cards if the cardholder is late on a payment by 60 days or more. For a more detailed list of the protections the CARD Act provides to consumer card, you can review this summary of its key features.

So you should think twice before responding to your next small business card offer. Yes, you will have a higher chance for approval, but you may end up paying dearly for it and will probably be better off sticking to your personal card.

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Credit card companies are having a real difficult time rediscovering the winning formula that enabled them to rake in huge profits before the financial crisis hit and losses started piling up. The record-high default and delinquency rates from last year have subsided, although they are still above historic levels, but consumers are now much more conservative in their spending and debt management. Additionally, now that the CARD Act is fully in force, issuers are restricted in their ability to raise interest rates, while penalty fees are capped and charging over-the-limit fees requires the cardholders’ prior enrollment in an overdraft protection program.

Here are some data from the WSJ:

Card companies are struggling to recover from $1 billion in losses racked up last year as a result of the financial crisis. Auriemma Consulting Group, a New York firm that specializes in the payments industry, estimates that card companies could earn about $4 billion this year. That is less than a quarter of the record $18 billion earned in both 2006 and 2007, according to Auriemma, which doesn’t include financial results from American Express Co. or Discover Financial Services Inc.

It is hard for issuers to make money when cardholders are not using their cards. Again from the WSJ:

The amount of outstanding credit-card loans shrank 10% last year, to $772.19 billion, due to tighter lending standards and a drop in consumer spending, according to the Nilson Report, a Carpinteria, Calif., industry newsletter.

Those loan portfolios are continuing to shrink. Chase, one of the largest issuers, has shaved more than $20 billion from its $127 billion portfolio. Over the past year, the bank has pulled back credit from its riskiest and least profitable customers.

The CARD Act is taking its toll too:

New federal card rules are expected to drain $11 billion a year from the industry over the next five years, said Robert Hammer, who runs a credit-card-consulting firm in Thousand Oaks, Calif. Those losses represent lost fee and interest revenue from charges that the law, enacted this year, bans. The losses also include higher costs of compliance with the law.

The CARD Act ensures that, even if consumers soon relapse into their happy spend-now-pay-for-it-later habit of the pre-crisis days, traditional card products will never be as profitable for credit card companies as they once were. Issuers of course realize that they need to get creative and are hard in search for alternatives.

One such alternative may turn out to be the prepaid card, until now the domain of little known, second-tier issuers. They are largely unregulated by the CARD Act and are typically issued to consumers with sub-prime credit scores. Used as debit cards, prepaid cards draw funds not from the cardholder’s checking account, but from an account with the issuer that is funded by the cardholder. Once the funds are used up, the cardholder has the option of re-loading the account.

Another alternative is the charge card, which is already being pushed hard by some of the largest issuers, including American Express and Chase. The biggest difference between credit and charge cards is that with the latter product, cardholders must pay off their balance at the end of each monthly cycle.

Yet another possible alternative is the private label card. Such cards are issued by credit card companies under the name of a different organization, such as Home Depot credit card offered by Citibank. Recently we learned that Target’s credit card profit rose to $149 million in the second quarter, up from $63 million a year earlier.

It may take them some time, but issuers will surely find a way to boost their profits. Whether they will be able to take them back to the pre-crisis levels remains to be seen, but that will depend not only on their own creativity, but also on the consumers’ willingness to cooperate.

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The average interest rate on existing credit cards reached 14.7 percent in the second quarter, up from 13.1 percent a year earlier, according to a study by Synovate, a market research firm owned by the Aegis Group. It is the highest level since 2001. The interest rate increase looks even more dramatic when you measure the spread between the prime rate – the benchmark against which card rates are set – and average credit card rates. Currently, the gap is 11.45 percent, the largest in at least two decades, according to Synovate.

Why are credit card interest rates at record highs at a time when other rates are at record lows? Well, for the WSJ at least, the answer is fairly straightforward:

It was among our safest predictions that reduced credit to consumers would result when the Federal Reserve announced new credit-card rules in 2008, and then Congress followed up with the Credit Card Accountability, Responsibility and Disclosure (CARD) Act of 2009. By limiting the ability of banks to increase rates on delinquent borrowers and to charge fees on unprofitable customers, Washington encouraged card issuers to be more selective in advancing credit and to demand higher rates when they do.

It’s a simple equation. If politicians make it more difficult and expensive for banks to lend, customers will find it more difficult and expensive to borrow.

Well, there is truth in that, but the equation is far from simple. Yes, the CARD Act is costing credit card companies a lot of money by preventing them from charging some fees, while placing caps on others and restricting their ability to increase interest rates. But there is another factor driving up interest rates and it is the economic crisis.

Credit card defaults and late payments were at record highs throughout 2009 and are still above historical averages today. Issuers simply couldn’t afford to offer credit to anyone but the safest borrowers and credit card offers plunged.

The trend is beginning to reverse, however, and the number of new credit card offers in the first quarter was up by 29 percent over the same period in 2009, according to Synovate. This doesn’t mean that interest rates are falling, though. Most credit card offers now come with variable interest rates, which add a certain percentage to the prime rate.

Now, the prime rate can’t go much lower and will eventually start rising as the economy recovers, pushing up interest rates on variable cards along with it. Does that mean that consumers are condemned to high credit card interest rates for the foreseeable future? Well, that would depend largely on the pace of recovery. The bank card industry is a very competitive one and, once it starts to look as if things are getting back to normal, credit card offers will become more attractive and interest rates will go down.

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• No fixed monthly fees.
• 24 / 7 customer support.