Fed moves to close credit card application fee loophole
Reform law's fee cap can't be dodged by charging to process paperwork
The Federal Reserve Board is taking steps to close a loophole in the new credit card law that allowed some card issuers to sidestep a 25 percent cap on fees charged during the first year of new card accounts.
In proposed rules issued Tuesday, the Fed said credit card application fees -- also sometimes referred to as "processing fees" -- that are assessed to some credit card applicants must be included in calculations of the 25 percent cap.
What this means: Issuers currently charging application fees may have to eliminate the fees or lower them to comply with the Fed's proposed rules.
Josh Frank, a senior researcher for the Center for Responsible Lending, calls the application fees "a deliberate attempt to circumvent the law." He says the Fed's clarifications are "a good thing" and show that regulators are "listening to and paying attention to efforts by issuers to get around the law and to exploit what they consider loopholes."
The Credit CARD Act of 2009 caps fees charged during the first year of a credit card account at no more than 25 percent of the account's credit limit. Thus, an account with a $400 credit limit cannot be charged more than $100 in fees during the first year. Examples of these initial fees include: annual fees, administrative fees, security deposits and monthly maintenance fees.
These types of upfront fees are typical for subprime credit cards issued to people with bad credit. They are known in the industry as fee-harvesting credit cards because the initial fees are so high that they use up the available credit on the accounts, rendering the cards almost useless for purchases.
Issuers of subprime cards defend their products, saying subprime borrowers are riskier customers and must pay higher fees and interest rates to offset the likelihood that they will default on their credit card loans.
The CARD Act limits fees on open credit card accounts. Since the law was enacted, some credit card issuers have begun to charge an application fee "before" an account is opened. They argue that since the credit card account is not yet open, that processing fee doesn't count toward the 25 percent cap.
Not so, says the Fed.
"Application and similar fees that a consumer is required to pay before a credit card account is opened are covered by the same limitations as fees charged during the first year after the account is opened," according to the Fed's press release.
Says Frank from the responsible lending consumer group: "We and other consumer groups had expressed concern about an offer that exceeded the 25 percent limit on fees ... It was considered a gray area the way it was written. We don't think it necessarily was a loophole, but it's good to have it clarified. The issuers now understand that this is not allowed."
"Some banks had been charging high application fees in addition to significant fees after the account was opened. Now it is clear that the total of these fees must abide by the 25 percent limit," says Lauren Bowne, a staff attorney for Consumers Union, the nonprofit owner of Consumer Reports magazine.
One lender, for example, First Premier Bank, charges a $25 "processing fee" to people applying for its Classic Credit Card. (Note: Fees and interest rates offered online to potential customers may vary depending when you check offers. Thus, processing fees may be higher for some applicants.) As the bank's website notes, the fee is refunded if applicants are rejected for the card, which may carry a $300 credit limit depending on the applicant's creditworthiness. The card carries a 59.9 percent APR. There is also a $75 annual fee -- which is exactly 25 percent of the credit limit.
Under the new Fed rules, First Premier would have to include the $25 processing fee in calculating whether it has exceeded the 25 percent cap on fees during the first year.
|How to comment on the proposed rules|
The public will have 60 days to comment on the proposed rule changes. To submit comments online, go to the Federal Reserve Board's website.
Comments may also be submitted in the following methods:
To view comments submitted on the proposed rules, refer to R-1393.
First Premier executives could not be reached for comment on whether they plan to revise their processing fee policies in light of new proposed rules.
Upfront application fees were among several CARD Act provisions addressed in the Fed's proposed rules.
According to the Fed, "clarification is needed to resolve confusion" over how some credit card issuers are applying aspects of the new credit card law. "The proposal is intended to enhance protections for consumers and to resolve areas of uncertainty so that card issuers fully understand their compliance obligations," according to a press release issued by the Fed.
Other CARD Act clarifications
Among the other clarifications:
- No-interest promotional programs. Credit card offers that feature no interest or waived interest during a promotional period are given the same consumer protections as those that offer reduced or teaser interest rates. According to the Fed: "A card issuer that offers to waive interest charges for six months would be prohibited from revoking the waiver and charging interest during the six-month period unless the account becomes more than 60 days delinquent." Says Bowne from the consumer group: "Consumers can be sure that if they sign up for a deferred interest payment plan (0 percent for 12 months) they will not lose their promotional rate unless they pay 60 days late. Previously, banks could lure consumers in with by promising to waive interest for a year, and when a consumer pays one day late, the interest free promotion disappears. The rule rightly clarifies that this is not permissible under the CARD Act."
- Assessing ability to pay credit card loans. The CARD Act requires issuers to take steps to assess a consumer's ability to pay credit loans when he or she applies for a new card or when the credit limit on the account is increased. The Fed's proposes to clarify that this assessment of ability to pay be based on the individual applicant or cardholder's income rather than on household income.
- Accounts that don't have credit cards. When consumers have credit accounts that don't actually issue credit cards, the CARD Act's consumer protections still apply to these accounts if they are used to access a line of credit and purchase consumer goods and services. "For example, creditors may offer open-end credit accounts designed for online purchases that function like a traditional credit card account but can only be accessed using an account number. In these circumstances, the Board believes that [Truth in Lending Act] credit card protections should apply."
Gift card disclosures take effect Jan. 31, 2011
The Fed also issued final rules on Oct. 19 regarding new gift card disclosure rules. Starting Jan. 31, 2011, gift certificates, store gift cards and general use prepaid cards that were produced before April 1, 2010, cannot be sold unless buyers are informed of the expiration date on the cards through in-store disclosures or other methods.
The effective date of the gift card disclosures was originally Aug. 22, 2010, but regulators moved it back to January after card issuers expressed concern that they would have to destroy cards that had already been printed without the new expiration date disclosures.
Any gift cards produced after April 1, 2010, must bear the disclosures.
See related: A guide to the Credit CARD Act of 2009, Cost of bad-credit credit cards rising due to reform law, Issuer of 79.9 percent credit card defends its product, Fed finalizes new gift card rules
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