Despite placing the economic collapse and Great Recession in the rearview, consumers still haven't shied away from subprime credit offerings.
By nearly all measures, consumer credit in the United States doesn't look great. According to the Federal Reserve Bank of New York, mortgage debt ($8.63 trillion, up $258 billion, student loan debt ($1.34 trillion, up $83 billion) and auto loan debt ($1.17 billion, up $96 billion) have ballooned within the last year. It also doesn't help that credit card debt has also soared ($764 billion, up $52 billion).
Roughly 11% of all student loan payments are past due, as are 7.5% of credit card bills. Despite this, and despite the fact that more than a quarter of Americans (26%) check their credit scores monthly or more often, nearly one in eight (12%) have never checked their scores. An online survey by finance site NerdWallet and Harris Poll conducted in April found that 23% of consumers think they have one credit score (you have several calculated based on what you're buying) and (41%) think carrying a balance on a credit card improves your credit score (nope, quite the opposite).
Part of the issue is the overall size of the subprime credit market. According to the 2012 Census, an estimated 48 million Americans, including more than 43% of Millennials (or 30 million people ages 18 to 34), have credit scores below 600. That's roughly 20% of U.S. adults, the lowest such percentage in roughly a decade, but still a huge number. All told, NerdWallet says 16 million Americans with subprime credit are carrying credit cards in an attempt to improve their credit.
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This becomes an issue when you're using a card from a subprime provider. Those cards are easy to get, with the Consumer Financial Protection Bureau's 2015 Consumer Credit Card Market report noting that 80% of folks who applied for subprime cards in 2013 and 2014 got them, compared to just 25% of applicants for standard, mass-market cards. It helps that 55% of subprime applicants were prescreened, as opposed to just 13% of all mass-market cardholders, but few consumers want subprime drawbacks that include application fees, processing fees, maintenance fees and authorized user fees. These cards also tend to charge annual fees of as much as 25% of a card's credit limit and annual percentage rates, or APRs, near or exceeding 30%.
Altogether, that's more than $150 a year in unavoidable fees and nearly $2.5 billion each year for all subprime cardholders combined, compared to the average cardholder. In fact, while major card issuers get 80% of their consumer revenue from interest, subprime issuers get 58% of total consumer revenue just from fees alone. A subprime cardholder pays whether he or she used the card or not.
Isn't all of this apparent in the cardholder agreement? Not necessarily. As the CFPB points out, cardholder agreements for subprime cars are 70% longer, on average, than the typical agreement from both mass-market issuers and credit unions. Also, they're more difficult to read, on average. The CFPB notes that large banks and credit unions produce agreements that should be readable by a high school graduate, while subprime agreements are written at a level suitable for someone who has completed two years of college. That's an interesting strategy, considering that the CFPB notes that -- in 2013 and 2014 -- more than half of mailings from subprime card issuers went to households with no education beyond high school. It's also worth noting that, between 2012 and 2014, the share of subprime card mailings to heads of household without a college education doubled.
"Subprime credit cards are the fake metal jewelry of the credit card world: they might look like the real thing, but in the end, they can end up hurting you," says Kimberly Palmer, NerdWallet's credit card expert.
The subprime credit card market just keeps growing. Credit rating agency DBRS notes that subprime account openings were the fastest-growing segment of the credit card market between the third quarters of 2015 and 2016. As of 2015, 50% of Americans with credit scores below 620 had credit cards, according to the Federal Reserve Bank of New York. That hasn't reached the pre-recession level of more than 60%, but it's getting there.
Also, subprime cards are rigged not to help you. According to the NerdWallet poll, 15% of cardholders say improve their credit if they had regular access to their credit score. However, ff the 10 subprime cards we looked at, only one provided a free monthly credit score. That's a big issues for Millennials, 38% of whom have subprime credit and 24% of whom believe they'd have better credit if they knew their credit score.
Why do credit scores matter? Because your credit health is determined by five categories: payment history, credit utilization, length of credit history, mix of account types and new credit. Credit utilization is the second-most important factor and is based on the amount of available credit you're using.
Experts recommend keeping utilization below 30%, or keeping your credit card balance under $300 if your limit is $1,000. However, according to TransUnion, the average total credit line for subprime cards has decreased by more than $1,000 since the first quarter of 2010. Over the same time frame, the average total credit limit for superprime cards — those for excellent credit — has increased by more than $4,000.
As a result, utilization on the average subprime credit card was 94%, while those superprime users with higher average limits on their cards only use 11% of available credit. While those ceilings limit the amount of debt that consumers can accrue, they increase overall credit utilization and keep users from improving their credit scores.
"Credit utilization as high as 90% will hurt your score because it signals an over-reliance on credit, which lenders might interpret as high-risk," says Heather Battison, vice president of TransUnion.
It isn't as if cardholders' recession-era austerity has faded completely. NerdWallet says a quarter of Americans surveyed (25%) feel much more or somewhat more negative about credit cards since the most recent recession. But 40% haven't changed their credit card habits, largely because they don't feel that there's a better option available.
The alternative they seek is a secured card. Such cards require a refundable cash deposit, usually equal to the card's limit but sometimes less. The deposit reduces the risk to the issuer, so secured cards are an option for people with bad credit. Secured cards often have lower annual fees and APRs — an average of less than $20 a year and less than 20%. In some cases, they also allow a cardholder to "graduate" to a better, non-secured card once they've shown some responsibility. In all cases, they refund the deposit to the cardholder once the account is closed.
NerdWallet looked at ten popular subprime cards and nine secured cards to determine the nonrefundable yearly costs of each. The subprime cards cost an average of $154 the first year and $166 in each subsequent year; the secured cards had an average of $26 in nonrefundable fees in the first year and $19 in following years. That's a difference of $129 to $146 per year. According to TransUnion, the average subprime cardholder has 2.48 credit cards, as of Q1 2017. Though the Federal Reserve Bank of Philadelphia says secured cards make up less than 1% of the total consumer credit card market, they're a valuable tool for those with terrible credit.
"A strong economy means we're seeing credit card issuers increase the number of their subprime credit card accounts — but it also means that these less expensive options are more easily available, too," Palmer says. "Subprime credit cards might be easy to get, but they are not good to have."
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Editors' pick: Originally published Sept. 13.