Fed moves to close credit card loophole that allows excessive fees

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By Ylan Q. Mui
Washington Post Staff Writer
Tuesday, October 19, 2010; 11:08 PM

The Federal Reserve on Tuesday moved to stop credit card issuers from using a regulatory loophole to charge the most vulnerable customers exorbitant sign-up fees.

The proposed regulation is aimed squarely at "fee-harvester cards," targeted at consumers with poor credit histories. The cards carry interest rates as high as 79 percent and typically have limits of a few hundred dollars. They also come with hefty annual fees and other charges that can quickly eat up the available credit.

One card described in a 2007 report by the National Consumer Law Center, an advocacy group, had a $300 limit with $247 in monthly and annual fees, leaving consumers with only $53 to spend.

The landmark Credit Card Act that was enacted last year sought to tamp down such practices by capping card fees at 25 percent of the credit limit for the first year of use. Web sites of some credit card companies state the cards are no longer available.

But some issuers found a way around the law by charging a sign-up fee before the account is actually opened. One such card advertised on First Premier Bank's Web site assesses a $25 processing fee to register for the card. The site notes, however, that "for convenience this Processing Fee can be paid over time."

The initial credit limit on First Premier's card is typically $300 and it carries a $75 annual fee - 25 percent of the available credit and technically in compliance with the law. Under the Fed's proposal, however, card issuers would be required to include the sign-up fees in that calculation, putting First Premier's fees at 33 percent of available credit.

"This was a huge loophole," said Adam Levin, co-founder of Credit.com, a credit-report Web site. "I really believe the Card Act is a work in progress."

Officials at First Premier, which is based in South Dakota, did not return several calls seeking comment. Card issuers have said that high interest rates and fees are necessary in order to extend credit to risky customers, who often pay late or not at all. In local news reports, First Premier said the new regulations have hurt its business and forced it to slash hundreds of positions. It also said it is retooling its portfolio of products.

"We think it's a failed business model," said Lauren Saunders, managing attorney for the consumer law center. "It's appropriately getting squeezed."

Curtis Everson, president of the South Dakota Bankers Association, said that state has lost 3,000 finance jobs over the past two years as the sweeping industry overhauls took effect. He said that tighter regulations could mean that businesses will no longer be able to afford to offer credit to distressed consumers.

"Congress and the regulatory community are imposing their judgment over what's appropriate in terms of risk-based pricing for a high-risk group," he said. "I think there's clearly a difference of opinion."

The Fed also proposed several other changes to the credit card regulations: Issuers would not be able to raise interest rates on certain promotional offers unless a customer was more than 60 days late on a payment, and issuers would have to take into account customers' independent income, not just household income, when determining whether they are eligible for credit.

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