Do banks have short-term memory problems or has greed once again taken control? The dust has barely settled on what’s left of a devastated housing market, its demise caused in no small part by a flood of sub-prime mortgages to people who simply couldn’t make their mortgage payments. And now, the same thing could happen again with credit cards.
For the past two years, ever since the sub-prime mortgage debacle, banks have been acting somewhat responsibly by making it impossible or at least difficult for people with poor credit scores, those considered to be sub-prime borrowers, to borrow money.
But now, according to CardHub.com, the sub-prime category is no longer taboo. In fact, it says the number of credit card solicitations being sent to people with FICO scores of between 620 and 660 is up 300% in the last six months.
Wasn’t this the first phase of what got us into trouble three or four years ago? What’s that famous saying, “history repeats itself because people forget?” Is it possible the banks have forgotten the recent past? Or do they believe that this time it will be different?
Subprime has always been an important market segment for banks because it generates more revenue than from more credit-worthy customers. They get to charge late fees and annual fees along with higher interest rates. It’s estimated that on average, lenders received 70% of their revenue from subprime borrowers.
The financial crisis and credit freeze triggered by the implosion in the sub-prime mortgage market forced banks to write off billions in losses of bad debt. But now that they’ve been bailed out and delinquency rates are on the decline, credit card issuers aren’t as worried and once again see these risky borrowers as a way to make more money. At least until they start to default again.
It wasn’t that long ago when banks would only offer 0% APRs on credit cards to people who had credit scores of 720 or higher. But now banks say credit conditions are improving. Why would that be? The job market hasn’t recovered. The housing market hasn’t recovered. The economy is still limping along and yet the banks say credit conditions have improved.
Are they deluding themselves, or do they know something we don’t? Perhaps, if they make credit available to more people, this will in itself improve the credit market. Could that possibly be the answer?
According to direct-marketing data tracker Mintel Comperemedia.com, one in four mail solicitations sent from issuers for new credit cards are sent to subprime and near-prime borrowers. Andrew Davidson, a senior vice president at Mintel, was quoted by SmartMoney magazine as saying “the pitch often offers solace, assuring such borrowers that they're entitled to a new beginning or that their blemished credit history doesn't mean they can't get a credit card.”
Odysseas Papadimitriou, chief executive of CardHub.com, says banks are hedging their risk with card terms that aren't all that favorable. The average interest rate for subprime accountholders is about 20%, up from 17.6% a year ago and nearly all of these cards come with an annual fee of $39 on average. He says the exception is Capital One's Standard Platinum card that is free the first year and $19 per year after that. The one saving grace is that the average credit lines for subprime borrowers are often very low, sometimes just $300 to $500.
But then how many sub-prime mortgages had to be sold and then defaulted on before that market caved in?