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Evils of 'fee harvesting' credit cards known for a long time

Beware of cards that charge upfront fees and carry low limits

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Consumer advocates say they have long warned of the evils of the type of credit cards targeted in recent federal enforcement action. The "fee-harvesting" credit cards offer low credit limits and charge upfront fees to consumers with bad credit.

Fee harvesting credit cardsThe cards often leave cardholders with very little available credit before the cards are used for the first time, putting users in danger of incurring over-the-limit fees on purchases. Consumer credit counselors warn their clients to avoid the cards. (See 5 things to know about fee-harvesting credit cards.)

"Fee harvesting cards are an example of how credit card issuers have shifted from interest to fees as the way they make their money," says Chi Chi Wu, an attorney with the National Consumer Law Center, a Boston-based consumer rights agency. Wu is co-author of a November 2007 study that chronicled many of the abuses critics say are rampant in fee harvesting cards. Among them: mailers and advertisements that claim the cards carry no fees but actually assess hefty fees at the outset. The cards generate millions in fees for credit card issuers but extend limited purchasing power to cardholders.

In essence, consumers are "victimized," according to Wu's study, and end up paying "steak prices for Hamburger Helper credit."

The Federal Trade Commission (FTC) and the Federal Deposit Insurance Corp. (FDIC) filed complaints on June 10, 2008, seeking $200 million in restitution for consumers who paid fees to ;Atlanta-based CompuCredit Corp. and two U.S. banks. (See: FTC: Subprime credit card marketer must repay $114 million.) Federal officials allege the companies violated the Federal Trade Commission Act, which bans unfair and deceptive practices, by failing to disclose upfront fees, misrepresenting the amount of credit that would be available to customers and claiming a debt collection program was really a credit card offer. A third bank, Columbus Bank & Trust of Columbus, Ga., agreed to a settlement plan that calls for it to pay $2.4 million in fines and set up a $7.5 million restitution backup fund. 

TYPE OF CARDHOW IT WORKS
Fee-based Visa with $300 limit Although advertised as having no upfront fees, the cards assessed as much as $185 on a $300-limit card, leaving only $115 in available credit.
Visa with "up to $3,250" limit Customers must wait 90 days to have access to the full credit limit. Up to half of the available credit is withheld and consumers' spending habits may be monitored during the first 90 days.
Debt-transfer Visa program Consumers with charged-off debts are offered a credit card on which to transfer their unpaid debts. However, they are enrolled in a debt repayment program rather than a credit card and do not receive a credit card until 25 percent to 50 percent of the charged-off debts are repaid.
The brand names of the credit cards involved in the federal probe were: Aspire, Aspire A Mas, FreedomCard, Tribute, Imagine, Majestic, Aspen, Emerge and Fingerhut Credit Advantage.

Source: U.S. Federal Trade Commission

What's wrong with fee harvesting
CompuCredit CEO David Hanna vehemently denied regulators' allegations, as did representatives from the three banks cited. CompuCredit, however, was featured prominently in the 2007 national law center study as an example of what's wrong with fee harvesting. It's not illegal to issue fee harvesting credit cards, but using deception in advertising the terms of the cards violates federal law.

CompuCredit, which is publicly traded on the NASDAQ stock market, started in 1996 by a family of former debt collectors who had sold pots and pans through direct mail fliers and made a failed attempt to enter the health insurance industry. CompuCredit tried three times and failed to get its own charter to become a full-fledged bank and thus issue its own credit cards. Instead, the company relied on third-party agreements that allowed banks to issue the cards while CompuCredit handled marketing for new accounts, servicing existing accounts and collections.

Reverse redlining
The 2007 study also points to another concern with fee harvesting: Marketers appear to target low-income, minority communities for low-credit limit, high-fee credit cards. CompuCredit and the banks involved in the federal probe contend they are providing a valuable service to underserved communities. "We believe these programs serve consumers with special credit needs and we remain committed to providing access to credit to these underserved consumers," according to a statement released by one of the banks, First Bank of Delaware.

According to the law center study, CompuCredit's business appeared to thrive on issuing credit cards to people "viewed as unlikely to pay their bills" and desperate to get credit cards to rebuild bad credit. Consumers who received fee harvesting credit cards were typically people with bad credit histories who were trying to rebuild their credit and establish a record of good payments.

David Jones, president of the Association of Independent Consumer Credit Counseling Agencies (AICCCA), describes fee harvesting credit cards as "horrible stuff." The AICCCA is a nationwide group that represents 36 nonprofit consumer credit counseling agencies that operate 178 counseling offices in 38 states. The agencies offer debt management advice, credit counseling and financial education to clients drowning in debt, trying to manage huge credit card bills or improve their credit scores.

Jones says of issuers who market fee harvesting credit cards: "They've taken huge advantage of these people." Accredited credit counselors do not recommend the fee harvesting cards to clients with bad credit, Jones says. "It's unusual for a counselor to tell people to take on any other debt instrument. We are attempting to get people out of debt."

The fee harvesting credit cards typically carry low credit limits (only $300 to $500). By the time issuers deduct fees for opening the account, annual fees or monthly maintenance fees, the cardholder has very little available credit. People who make purchases on those cards thinking they have the entire $300 balance available to them, risk going over the limit and getting assessed with over-the-limit fees for every month they continue to exceed the limit. Customers who pay late may be hit with late fees each month. Interest charges -- which could range from 8 percent to 20 percent or higher -- may be added to the balance.

In the CompuCredit cases, delinquent accounts were referred to a CompuCredit subsidiary, Jefferson Capital Systems LLC, which the FTC alleges engaged in harrassing, abusive, threatening tactics to collect on debts.

Those activities combined made for lucrative business for CompuCredit. "In plain English, the company collects enough money from its cardholders to cover the cost of finding customers, handling their accounts, paying other corporate expenses and getting money from investors, lenders or depositors," according to the national law center study.

The company had 5.7 million customer accounts as of Dec. 31, 2007, according to its 2007 annual report. Company financial records indicate CompuCredit made $171 million and $107 million in net profits in 2005 and 2006, respectively, but logged a $51 million net loss in 2007 attributed to the credit crunch.  

Brand name credit cards
CompuCredit credit cards involved in the two-year FDIC/FTC probe included the brand names: Aspire, Aspire A Mas, FreedomCard, Tribute, Imagine, Majestic, Aspen, Emerge and Fingerhut Credit Advantage. According to the FTC, these cards fell into three categories:

  • Fee-based Visa cards with $300 limits. The Aspire and Aspire A Mas (the Spanish-language version of the Aspire) were marketed to people with bad (or subprime) credit records. Many of the marketing materials for these cards advertised that certain upfront fees did not apply. However, consumers receiving the cards were immediately charged up to $185 in fees and charges, leaving as little as $115 in available credit. 
  • Visa cards with up to $3,250 limits. Consumers with slightly higher credit ratings received marketing materials offering "up to $3,250" in credit on Visa cards. However, half of the available credit on the cards was withheld for the first 90 days -- a fact that was never or inadequately disclosed. The FTC also alleges that CompuCredit monitored cardholders' spending habits during the first 90 days of the account and reduced credit limits based on undisclosed behavioral scoring models.
  • Debt transfer Visa cards. Consumers who fell behind on payments on the subprime credit cards were referred to CompuCredit's debt collection division -- Jefferson Capital. According to the FTC, consumers whose accounts had gone into collection were offered Visa cards on which they could transfer charged-off debts. The old debts would be reported to the credit reporting bureaus as paid in full, however, the consumers who agreed to the offer were enrolled in a debt repayment plan that required them to pay 25 percent to 50 percent of their balance before receiving the Visa card.

The June 10 complaint isn't the first time CompuCredit has had to refund money to consumers. In June 2006, CompuCredit and Columbus Bank agreed to compensate New York consumers for similar marketing, billing and collection practices. According to its 2007 annual report, CompuCredit's share of the restitution was $2 million plus a $500,000 fine from the New York Attorney General's Office.

Reform measures
The Federal Reserve Board, which also regulates banks, attempted to address some of the problems with fee harvesting cards in May when regulators proposed sweeping changes in rules governing credit card issuers. One of the proposals would ban issuers from charging upfront fees if "those fees or deposits utilize the majority of the available credit on the account."

Fees that exceed 25 percent of the available credit limit would have to be spread over the first year of card use, rather than piled on at the beginning. The national law center study recommends capping fees at only 10 percent of the available credit limit. All lenders would have to disclose all fees in solicitations and account opening and monthly statements, under amendments to Regulation Z of the Truth in Lending Act. Wu, however, says fee harvesting should be banned outright.

"Disclosure is only going to go so far in helping consumers avoid this," she says. "What's really necessary is to prohibit these kinds of companies from doing this."

To comment on this article, write to: Editors@CreditCards.com.

See relatedFTC: Subprime credit card marketer must repay $114 million, 5 things to know about fee harvesting credit cards, Feds seek $200 million for 'fee harvesting' credit cards, Fed backs rules to curb deceptive credit card practices

Published: June 18, 2008


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