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Banks cash in on fees from riskiest card holders
By Mitchell Pacelle
The Wall Street Journal
July 7, 2004

When Jennifer Reid opened her credit-card statement in April, she discovered how expensive it was to make full use of her credit.

The 42-year-old X-ray technologist had run through $10,000 of her $12,000 credit line on an MBNA Corp. card. In April, her annual interest rate jumped to 24.98 percent, up from 19.98 percent the prior month and far above the initial single-digit rate.

"I don't understand," she recalls telling an MBNA customer-service representative, complaining that she hadn't been late with a single payment. But the representative pointed out she had run up more than $5,000 in debt on two other cards. Also, she was making only slightly more than the minimum monthly payments. He said the company saw her as a credit risk.

For consumers who pay off their credit-card balances each month, shop aggressively for interest rates, and take advantage of generous credit-card rewards programs, consumer credit has never been cheaper.

But for others like Reid, who went into debt so she could move to a better job in Florida from South Carolina, the trend is in the other direction.

Card users, consumer advocates and some industry experts complain that banks are attempting to squeeze more and more revenue from consumers struggling to make ends meet. Instead of cutting these people off as bad credit risks, banks are letting them spend -- and then hitting them with larger penalties for running up their credit, going over their credit limits, paying late and getting cash advances.

"People think they are being swindled," says industry consultant Duncan MacDonald, formerly a lawyer for the credit-card division of Citigroup Inc., a consulting group that tracks the card industry, says credit-card fees, including those from retailers, rose to 33.4 percent of total credit-card revenue in 2003. That was up from 27.9 percent in 2000 and just 16.1 percent in 1996.

The average monthly late fee hit $32.01 in May, up from $30.29 a year earlier and $13.30 in May 1996, the company said. In 2003, the credit-card industry reaped $11.7 billion from penalty fees, up 9 percent from $10.7 billion a year earlier, according to Robert Hammer, an industry consultant.

Banks say that penalties and fees are a necessary component of new models for pricing financial services. Now, the banks say, they must rely on risk-based pricing models under which customers with the shakiest finances pay higher rates and more fees.

An MBNA spokesman declined to comment on Reid's experience but noted that one of the most important considerations in setting a card's interest rate is "how a customer manages his account." If a customer's financial circumstances change for the worse, he said, the bank raises the rate "as a way of balancing that greater risk."

What raises the hackles of customers is that many don't discover the rate changes and penalty fees until they have been hit with them. Those who complain are directed to disclosure statements that, says MacDonald, have ballooned from little more than a page 20 years ago to 30 pages or more of small print today.

Until the early 1990s, most banks offered one main credit-card product. It typically carried an annual interest rate of about 18 percent and an annual fee of $25. Cardholders who paid late or strayed over their credit limit were charged modest fees. Profits from good customers covered losses from those who defaulted.

Then card issuers, in an effort to grab market share, began scrapping annual fees and vying to offer the lowest annual interest rates.

By the late 1990s, banks were attracting consumers with low introductory rates, then subjecting some of them to a myriad of "risk-related fees," such as late fees and over-limit fees. A 2001 survey by the Federal Reserve showed that 30 percent of general-purpose credit-card holders had paid late fees in the prior year.

Credit-card late-payment charges have risen to as high as $39 for some customers, and fewer banks grant grace periods. Cardholders who exceed their credit limits face "over limit" fees as high as $39 a month.

In a survey of 140 credit cards this year, the advocacy group Consumer Action said 85 percent of the banks make it a practice to raise interest rates for customers who pay late -- often after a single late payment. Nearly half raise rates if they find out that a customer is in arrears with another creditor.

Consumer lawyers have lost a string of lawsuits challenging such practices. A little-noticed April ruling by the U.S. Supreme Court said credit-card companies don't have to include various penalty fees when they calculate the "finance charge" listed on a customer's monthly statement.

For now, the only way for consumers to know what they are getting into is to plow through the disclosure materials they receive when they open bank accounts or get new credit cards.

Most never do. Said Bank of America customer Richard Flynn: "We just opened a simple bank account, and they gave us a 78-page booklet, small print, and they expect us to read and understand it."

Reid, the Florida cardholder, says she is far more careful now about studying her credit-card mail. "I read every single solitary word now. I hope one of these days I won't have to have a credit card at all."




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