April 21, 2009 at 8:00 AM ET
When Mike Templeton looked at the credit card application his college-aged son received in the mail, his blood started to boil. The card promised an attractive 9.9 percent interest rate, but there was a catch. Buried in the fine print was a list of fees that seemed almost comical.
• Account set-up fee: $29.00
• Program fee: $95.00
• Annual fee: $48.00
• Monthly servicing Fee: $84.00 annually
• Additional card Fee: $20.00 annually
And then, at the bottom, was a sentence that it's hard to imagine someone could write with a straight face:
"If you are assigned the minimum credit limit of $250.00 your initial available credit will be $71.00 ($51.00 if you select the additional card option)."
Welcome to the world of low-credit score credit cards -- a destination more Americans are finding their way to as the economy continues to sputter and unemployment rises.
Most consumers take credit cards for granted as a necessary tool for living in 21st century America. Cards are incredibly convenient, and in some cases, a necessity. It's difficult to rent a car, book a hotel room, buy anything online or even rent a movie without a credit card. With billions of pre-approved credit card applications sent out each year, it's easy for many Americans to get plastic - in fact, perhaps too easy. But another segment of the population -- those who've got low credit, or no credit -- find themselves in an alternate universe, where credit card plastic can literally cost its weight in gold. The card Templeton was studying, issued by South Dakota-based First Premier bank, essentially has a $250 sign-up fee disguised a series of smaller fees.
"I wonder how many college kids have fallen for this?" said Templeton, who lives just outside Dallas. "Isn’t this usury under the guise of finance fees?"
It's not usury. Credit card firms get wide latitude on fees they charge, thanks to a Supreme Court decision in 1996 that affirmed banks are only subject to their home state’s laws, no matter where their consumers live. When levying fees, First Premier need only comply with South Dakota’s relaxed consumer protection law.
First Premier is hardly the only bank charging high fees. In 2007, the National Consumer Law Center reported on what it called "fee-harvesting" cards aimed at the low-end of the credit card market. With some of these cards, after fees are counted against the credit limit, consumers have virtually no credit left to spend, it said.
"It's hard to speculate why people sign up for these cards, but it's certainly possible they fail to notice these high fees," said consumer attorney Chi Chi Wu, who helped write the report. "It's an incredibly expensive product."
Consumers who have trouble getting credit cards are faced with two bad choices. They can either opt for what's called a "secured" card, which requires a hefty up-front deposit, or they can sign up for a card with hefty up-front fees.
With a secured card, consumers send a bank $200 to $500, then get back a credit card with an identical credit limit. The bank holds the deposit in case the consumer defaults on the card. With secured cards, the consumer is essentially borrowing his or her own money and paying interest for the right to carry plastic. After a user demonstrates a good payment history, some banks extend the credit limit and eventually offer the consumer a chance at a traditional unsecured card.
Those with bad credit might have trouble coming up with deposit money for a secured card, however. Fee-harvester cards fill this gap, because they require no up-front payment before the card arrives. Some also don't require immediate payment of the fees; the $200 or so in extra charges can be financed by the consumers. That can lead to even more credit trouble down the line.
'They are a tool'
"These have been around for a long time," said Howard Dvorkin, who runs Consolidated Credit Counseling Services, Inc., a credit-card industry-sponsored nonprofit that helps consumers get out of debt. "You're going to see more of them in the coming years. The reality is these are high margin products for banks. … It's an incredibly profitable sector of the credit card business if you know what you're doing. But it can also be incredibly volatile area."
Dvorkin isn't as critical of the high-fee cards as Wu. He said banks need to cover the risk of extending credit to customers who've already demonstrated they might not pay their bills.
"They are a tool, and sometimes tools cost a lot," he said. "It's a tool for teaching people about how to use a credit card ... but to be frank with you, the reason why they charge so many fees is because they can, because these people have nowhere else to turn. The justification on the banks’ side is these are riskier consumers. … But is it a good deal for a consumer? Probably not."
Both fee-harvester cards and secured cards have other gotchas, too. The Applied Bank Secured Visa card, for example, has no grace period. With most credit cards, consumers who pay their balance in full each month pay no interest on new purchases during a 25- or 30-day grace period. But with the Applied Bank card, the consumer is charged interest from the moment a purchase is made -- similar to taking a cash advance – even though the bank is already holding the consumer’s money as a deposit.
Linda Sherry, executive director of Consumer Action, said she'd seen a disturbing new trend in the low-end side of the credit card market -- cards that combine the worst features of both secured cards and fee-harvesters.
"Quite a few secured cards have processing fees of $99," she said. The means the bank gets its money up front and makes money on large fees, too. "It's gross, but not actually surprising."
One reason high-fee cards might be more aggressively marketing their product recently -- price controls are coming. New rules issued by banking regulators that take effect next year will limit the fees on cards to 50 percent of the available credit limit. That's still very high, but it would cut First Premier's fees on a $250 limit card in the example above from $179 to $125.
Despite that limitation, Dvorkin predicts that some credit card company will enjoy fast growth by deciding to extend credit to consumers who have only temporarily fallen on hard times.
"It happened after the last recession with Capital One," he said. "There are people coming out of the recession with beat up credit. There will be huge demand for products catering to the less credit-worthy, and traditional banks aren’t going to do it. "
RED TAPE WRESTLING TIPS
Bill Hardekopf, who runs a credit card comparison site called lowcards.com, said it's extremely important for consumers who have low credit to shop carefully for a credit card.
"You have to do a lot of research to make sure you don't sign up for something that is very, very bad for you," he said. He steers consumers toward secured cards as the better deal. It's important to find a secured card that offers a grace period, low fees and a bank that promises to place the security deposit in an interest-bearing account, he said.
It's also important to ask about the path to getting a standard, non-secured card.
“How many months of good payment history do you need before you qualify? Consumers should ask,” he said.
And for consumers whose chief goal is restored credit and a higher credit score, it's essential to learn if the card-issuing bank reports payments to the credit bureaus. Not all do.
One way to avoid high-cost cards is to use a debit card for online purchases and travel, but not all car rental companies accept debit cards for deposits. And not all consumers who have credit troubles can open a checking account and get a debit card.
Meanwhile, using a debit card does nothing to improve the consumer's credit score.
Dvorkin recommended avoiding the expensive credit cards if possible. Instead, consumers who want to rebuild their credit should start by re-establishing a relationship with a bank. One trick: Deposit money into a Certificate of Deposit, and then take out a small loan with the CD as collateral. Paying the loan back and getting "paid as agreed" entries on a credit report will slowly help improve a credit score.
Again, it's vital that the consumer's bank report payments to the credit bureaus, so be sure to check.