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For people with bad credit, getting access to credit cards and loans is hard. Some 10 years after the term "subprime credit' became synonomous with the Great Recession, lenders -- and consumers -- have embraced subprime credit cards.

Recent research highlights the huge price consumers who use these cards are paying, compared to more-credit-worthy Americans. In fact, their very structure can make it easier for people with not-so-great credit scores to get caught in a debt spiral. 

What Are Subprime Cards?

As the name suggests, subprime cards are for people whose credit scores often do not qualify them for a regular credit card. However, even with a bad score, subprime credit cards aren't the only available option. Borrowers also can access secured cards. It's crucial to understand the distinction before choosing the card you use.

Secured cards require consumers to make a security deposit, which determines the amount of credit available to them. No such deposit is required for subprime credit cards, one factor that can make them attractive to consumers tight on cash.  (See also: Credit Cards for People with Bad Credit

Experts suggest that those who are looking to rebuild their credit scores opt for a secured card. To see why, read below

Who Owns Subprime Cards?

It is difficult to estimate accurately how many people have subprime credit cards for two reasons. First, the definition of subprime credit itself varies across financial services providers; second, not all people with subprime credit scores have subprime credit cards.

Nearly a third of the country’s credit scores are under 660, qualifying them as subprime according to Federal Reserve Bank of New York (NY Fed) data. In a 2016 report, the NY Fed said that nearly half of all subprime consumers had a credit card. NerdWallet quoted data from credit bureau TransUnion indicating that there are 16 million people in the country with a credit score below 600.

According to Argus Information & Advisory Services data sourced by American Bankers Association (ABA), Q4 2016 saw 27 million new subprime credit card accounts opened, almost as many as for the same period in 2008. At the end of last year, 73 million, or nearly 21%, of all credit card accounts were subprime. "Subprime credit cards might be easy to get, but they are not good to have,” said Nerdwallet’s Kimberly Palmer.

Spotting a Subprime Card

Unfortunately, subprime cards don't come with that tag, which can make it tricky to figure out whether you're being offered one. A high fee alone isn't a good indicator. Airline credit cards like American Airlines AAdvantage card ($95 annual fee) and super-premium credit card like the Chase Sapphire Reserve ($450 annual fee) have high annual charges.

Consumers need to do their homework and observe some caution. 

A 2015 report by the Consumer Financial Protection Bureau (CFPB) pointed out some practices followed by Subprime Specialist Issuers (SSI), companies that specialize in issuing credit to consumers with subprime credit scores. Here are a few things to keep in mind based on the CFPB's findings.

  • Credit card agreements for such cards are complex and difficult to read. You won't be able to tell this, of course, but these cards are "disproportionally marketed to consumers with less formal education."
  • Pre-approved mail-in offers: If you're pre-approved, it means they don't care about your credit score and are marketing to consumers whose scores are likely to be poor. Be careful about accepting such offers without researching the cards on a credit card website.
  • Higher Minimum Payment: CFPB report suggests that subprime issuers typically demand higher minimum payments than regular issuers.

Here are some other clues that your card might be subprime:

Higher Fees, Few Rewards 

Your best bet is comparison shopping. According to a NerdWallet analysis of 10 subprime credit cards and nine secured cards, an average subprime card costs $154 in the first year and $166 in each subsequent year. Compare that with figures for a secured card – an average of $26 in nonrefundable fees in the first year and $19 in following years.

Even though the Credit Card Accountability, Responsibility and Disclosure (CARD) Act of 2009 provided some protection for consumers and limited the upfront fees to 25% of the credit limit, the industry contended that charges such as processing fee that are "technically paid before the account is opened" would exceed the that limit. The government agreed and made that exemption.

So what do you get for all that money? Very little. 

Take, for example, the Total Visa Credit Card issued by Mid America Bank & Trust Company: It offers an initial credit limit of $300 – however, the available credit to customers is only $225 after the deduction of the $75 annual fee for the first year. That is accompanied by a one-time processing fee of $89. The annual fee is $48 for every subsequent year, plus a $6.25 monthly servicing fee ($75 for the year). Another $29 will be charged for an additional card. All that for a card with an interest rate of nearly 30%.

What does the card not offer? Rewards points, cash back, frequent flyer miles. Subprime cards tend to offer none of these benefits. 

According to the CFPB report, during 2013 and 2014, mass market card issuers made 80% of their consumer-sourced revenue from interest rate charges and only 20% from fees. "The subprime specialists, by contrast, obtained 58% of their consumer-sourced revenue from fees over this same period. Interest accounted for only 42% of consumer-sourced revenue," said the report.

Lower Credit Card Limits, Higher Credit Utilization

As demand for subprime credit cards has increased, credit lines have shrunk. Earlier this year,  TransUnion estimated an over $1,000 drop in the average credit limit for subprime credit cards in the first quarter of this year, compared to the same period in 2010.

That is also echoed in a recent analysis published by the NY Fed. “The median limit on new cards for borrowers with scores over 760 was $8,500 in 2016 while the median limit of borrowers with credit scores under 620 was $750, as banks manage risks inherent in unsecured debt to nonprime borrowers.”

One problem with a small credit line: Consumers end up using most of it, which can force them into a high  credit utilization rate, which can further harm their credit scores. In a survey of 2,000 consumers NerdWallet found that the utilization rate for subprime card users was 94%. The recommended utilization rate lies within the 30% to 40% range. “Credit utilization as high as 90% will hurt your score because it signals an overreliance on credit, which lenders might interpret as high-risk,” said TransUnion Vice President Heather Battison.

To make it worse they provide little information about this damage. Of the 10 subprime cards reviewed by NerdWallet, only one provides free credit scores.

Delinquency Risk

High fees and high interest add to the cost of having a subprime card, making it easier to go into debt. And that's just what the latest research has been showing.

Data from the NY Federal Reserve show that people in the lower credit score brackets have increasingly begun to fall behind on their credit card payments for more than 90 days, which is considered seriously delinquent. Delinquency across all credit-score brackets is measured in terms of a "transition into delinquency" rate, which the NY Fed defines as "balances that have gone from current or early delinquency into ninety or more days late, as a percentage of the balance from the previous quarter that was less than ninety days past due."  

That rate stood at 22% for subprime credit card holders with FICO scores lower than 620 in Q2 2017, up from 18% for the same period a year ago. While the delinquency rates have not reached crisis level  yet, the increase is fairly noticeable.

If You Have A Subprime Credit Card...

Your overall goal should be to improve your credit rating enough to get a regular, mass-market card, ideally one with few or no fees. Your first step, if you can raise the cash, is to try to get a secured credit card. It won't come with a big credit line, but you could save a lot in fees. 

If getting a secured card isn't possible, concentrate on using your subprime card to climb up to a better credit score. "My suggestion for subprime consumers, or consumers in any risk tier with a low credit limit, is to work with what they have – don’t spend more than they can afford, pay all their bills on time and in full, and try to maintain about 30% credit utilization until they build enough credit to expand their credit line responsibly,” said Battison. 

As you build a record of on-time bill paying, check your credit rating. When it has improved, you can use credit card websites to research cards with better terms that you can apply for (see also: Credit Repair: How to Improve Your Credit Score) Be patient; this process can be measured in years, not months.

 

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