Credit Card Debt Law

Debt collectors in the United States are pretty annoying - but at least they are governed by a set of rules and regulations that put some restraint on their actions (and hopefully their conscience).  If you are in the unfortunate position of receiving phone calls from your creditors, things could be worse.

You could be in Spain, where Spanish debt collectors come after you in their top hats and tails.  The goal is to attract more attention to the debtor, and the Spanish company claims they are successful at collecting 70% of the debts.  The article discusses how copycats have sprung up in Spain - debt collectors are now running around dressed as clowns, monks, and Zorro trying to collect debts.  One company even started calling wedding guests asking for them to pay their fair share when the bride and groom didn’t pay a debt from their wedding.

I’m sure that there are plenty of stories about debt collectors in the United States who have crossed the line, but I’m hopeful that they haven’t showed up on anyone’s doorstep in a clown costume asking for payment on a debt.

The Democratic Convention is slated to begin this week in Denver and I’m already disappointed about Democratic Presidential Nominee Senator Barack Obama’s choice for his Vice Presidential Candidate - Senator Joseph (Joe) Biden from Delaware.

Delaware is the state of incorporation for most large corporations in the United States because of the perception (whether real or not is a completely separate question) that it has business friendly laws and a good climate for corporate governance.  And after many years of representing the interests of Delaware and its constituents, Biden can’t claim to be as free from corporate influence and Washington lobbyists as I’m sure Obama would like.  One of Biden’s largest political contributors was the world’s largest independent credit card issuer, MBNA, until it merged with Bank of America in 2005.

Among Senator Biden’s most noticeable departures from the agenda of Democrats during his time in Congress was his vigorous support of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005.  While it has been clear from media coverage that Biden was chosen for his foreign policy credentials (he’s the chairman of the Senate Foreign Relations Committee) and his political experience, one has to wonder why Senator Obama was willing to compromise measures to protect consumers in these troubled times by tying himself to a Vice Presidential Candidate with credit card company ties.

Prior to selection of Biden, Obama had put credit card reform and bankruptcy reform on his platform.  He also went so far as to blast McCain for his support of the 2005 bankruptcy legislation.  His choice of Biden suggests that credit cards and bankruptcy aren’t nearly as high on Sen. Obama’s agenda for President as he might like the American public to believe.  Biden, after all, supported the same bankruptcy legislation that he criticized Senator McCain for supporting, and has financed his election campaigns with the money paid from consumers to credit card companies.

It is, of course, possible that Biden was forced to yield to the wishes of his corporate constituents on the bankruptcy legislation in order to represent his state and might have voted different had he not had to represent their interests.  But given Biden’s previous presidential campaigns and the possibility of using the office of the Vice President as a stepping stone to the Oval Office in 2016, it seems unlikely that he would alienate this well financed constituency by taking up the public’s cause in the battle over credit card reform in Congress and the Federal Reserve.

This is the dilemma that Obama has introduced to the Americans who commented on (presumably in favor of) the Federal Reserve’s credit card reforms.  Of course, the alternative is to vote for the Republican Presidential Nominee, John McCain, who owes vast sums to credit card companies (I recently saw a story that he and his wife owe American Express over $1 million), doesn’t use the internet, and can’t tell you how many houses he owns without asking a staffer.

I wrote a brief post a couple weeks back about how banks and credit card companies might begin declaring and exercising a right of offset, particularly on its business customers.  If you don’t remember the post, it discusses how banks are increasingly seizing funds in the bank account of debtors who have business credit cards.  I also wondered whether banks would begin making the required disclosures to create a right of offset against individual, non-business, credit card holders.

Well, it turns out that increasing their use of the right of offset isn’t the only way that banks are stepping up their efforts to collect from those in credit card debt during this time of increasing debt and past due accounts.  Wells Fargo has taken a different tactic - it is sending letters to customers it believes are at risk of defaulting on their debt with offers of repayment plans and consumer credit counseling.  The San Francisco Business Times reported that the letter says, in part, “Wells Fargo strives to meet the financial needs of our customers, and intends to work with customers through both prosperous and challenging times.”

The effectiveness of the tactic is in doubt in my mind.  First, I expect that many individuals will throw the letter away thinking that it is junk mail.  Second, credit card debt in America is a taboo subject. Even if the debtor realizes that they are in trouble financially, I expect that the culture of silence surrounding debt will prevail over the offer to talk through the recipient’s credit problems with their debt holder.  The evidence in support of this point can be found in the housing market - there have been multiple offers by government and mortgage companies to assist subprime mortgage holders before they lose their home to foreclosure and yet foreclosures are increasing in the United States.  Moreover, I don’t think that Americans trust credit card companies, and by extension the bank holding their debt, enough to believe that their offer is genuine.  A recent article by the Associated Press cited a survey which found that 58% of Americans don’t trust credit card companies.  And debt collectors certainly haven’t done creditors any favors with their debt collection tactics.

I wonder just how far Wells Fargo is willing to go to help its customers.  Offers of credit counseling and payment plans seem like a relatively insignificant gesture.  Will Wells Fargo go so far as to negotiate the amount of debt and interest rate down in order to make payments easier if its debtors are in trouble?  Banks and mortgage companies have said that they are willing to help those having difficulty making their house payments, but the bureaucracy behind securing approval for a short sale that I have heard about anecdotally would suggest that the truth in practice is quite different.  If Wells Fargo were truly concerned about the financial health of its banking customers, I expect that it would have suggested more drastic measures that would both benefit consumers and increase the likelihood of debt repayment.

The San Francisco Business Times speculated that Wells Fargo might be using card balances, credit limits, and credit scores to determine which accounts to send the letter to. Just two paragraphs later, the article talks about a prior statement that Wells Fargo knows the income of its card holders flowing through their checking accounts.  It turns out that many holders of Wells Fargo credit cards also have bank accounts with Wells Fargo.  I wonder why the San Francisco Business Times did not suggest that Wells Fargo might be looking at the checking account balances and income of its customers in order to determine who is at risk of default?  My mind is running rampant with privacy concerns about this potential practice.

Wells Fargo isn’t the only bank that’s trying to collect on its problematic accounts.  The Houston Chronicle, in an article that has since disappeared into the depths of the internet, took note of a more traditional method for debt holders to collect debt owed to them that is increasing - lawsuits.  One lawyer representing consumers said that there were 10 times more lawsuits filed in Dallas, Texas, over consumer credit card debt than three years ago.  As courts find ways to streamline the legal process for smaller consumer debts and debtors don’t find the same protection in the bankruptcy laws that they once did,  debt holders are finding that the potential financial reward from a judgment compared to the costs of bringing a lawsuit weighs in favor of litigation.

One factor that may be driving the increased litigation is the likelihood that the debtor will not retain an attorney to protect their interests.  A recent Wall Street Journal article noted that the cost of hiring an attorney for a Chapter 7 bankruptcy filing averages about $1,000 - a pretty large chunk of change for those without sufficient money to pay their creditors. Representation by a lawyer for a Chapter 13 bankruptcy averages about $3,000.

Despite the potentially high cost, a brief look around the country indicates that bankruptcies are up a substantial amount.  Bankruptcy filings are up 31% in New York in the first seven months of 2008, according to the NY Daily News. San Jose, California, has seen a 70% increase in the number of bankruptcy filings over the past year, according to the San Jose Mercury News.  While some might blame the increase in filings on the irrational exuberance of the nation’s youth taking on credit card debt, it’s seniors who have been hit particularly hard in current times, composing approximately 22 percent of bankruptcy filings, according to the Corporate Dispatch.

How are corporations faring in these economic times?  It’s a safe assumption that corporate bankruptcies haven’t increased at quite the pace that law firms would have expected - as the Wall Street Journal recently profiled them as waiting for work   - though there have been some high profile bankruptcies recently - Steve & Barry’s, Bennigan’s, and Mervyn’s to name a few.

Fair Isaac, the developer of the proprietary model used for the widely accepted FICO credit score, has announced that it has reversed its 2007 FICO 08 decision to remove the effect of an authorized user on a credit card account on the credit score of the authorized user. Its press release explains that it will implement patent pending technology to distinguish legitimate authorized or supplemental users from intentional attempts to tamper with an individual’s credit rating during its calculation of credit scores.

Prior to its 2007 decision to prevent credit card piggybacking, families added spouses and children to credit cards as authorized users to permit them to use the credit card for purchases as well as build a positive credit history and boost their credit scores when they may not otherwise be able to qualify for credit at that interest rate. An authorized user is permitted to use the credit card but is not responsible for any money charged to the account (including their own purchases). More than 50 million people are authorized users on another individual’s credit card.

For those with a poor or unestablished credit history, or a bad credit score, it allowed them to borrow and use the credit of another through the requirement that the account holder take responsibility for repayment of the debt owed on the account.

Why did Fair Isaac make the change to remove the effect?

During 2006-2007, several websites and credit repair agencies offered those with bad credit the ability to artificially inflate their credit score by renting the good credit of an anonymous individual. The individual with poor credit paid the credit repair company which then paid a portion to the individual with a good credit score and credit history. Credit repair firms were charging thousands of dollars for this sort of quick fix. The concern was that individuals were artificially (and perhaps fraudulently) inflating their weak credit rating and causing lenders to take on a risk of default on the debt that they were not properly compensated for.

Why reconsider the decision and allow authorized user accounts to impact credit scores?

• The Equal Credit Opportunity Act requires that lenders consider the credit history of accounts which both spouses are permitted to use when they assess a spouse’s credit risk. If the FICO score did not consider authorized user accounts, lenders would have to find another way to meet this requirement.

• Critics objected to the removal of authorized user accounts from credit score considerations because it would leave up to 3 million people without sufficient credit history to generate a credit score, and others would be subject to a lower credit score, increasing the cost of their borrowing.

• Fair Isaac obviously felt that the new calculation method for the FICO credit score sufficiently protected lenders from abuse and eliminated the credit repair quick fix that authorized user accounts offered.

When will the change take effect?

The press release by Fair Isaac says the change is expected to take several weeks and will be implemented as soon as possible. But a Bankrate article notes that it could be a long wait.

Is piggybacking legal?

There has been vigorous debate over whether artificially inflating credit histories through illegitimate authorized users (non-spouse, non-children) is legal. I’m not going to provide any legal advice - you should consult your attorney.

How much could you get for renting your credit history?

From numbers that I have seen on the internet from prior to the 2007 decision to remove the effect, credit repair providers were paying between $200 and $700 per account, about 25% of the amount paid by the debtor for credit repair. More money was paid for seasoned tradelines with high credit limits compared to newer accounts with smaller credit lines.

What companies are involved in credit score piggybacking, which is also known as renting a credit score or adding a tradeline?

I found a few companies offering this service via Google, but many of the providers that I saw mentioned in 2006-2007 news articles no longer offered this service on their website, had a non-functioning website, or had not yet updated their website to reflect the recent change in the scoring model.

Are any of these credit repair companies reputable?

No idea. EXTREME CAUTION is warranted.

How much could the credit score of the authorized user increase?

An anecdotal story used by Bankrate in a 2007 article stated that the individual had a 65 point increase. Of course, only the history of the account that one is an authorized user for is considered in the authorized user’s credit score, and every account is different. The other accounts of the primary account holder do not pass any benefit or detriment - so it’s impossible to draw conclusions from the credit score of the account holder.

Some have warned that authorized user accounts are not a cure all since they aren’t in and of themselves a major factor in your credit score. Additionally, any effect now may be less because it may be that Fair Isaac has downgraded the effect of authorized user accounts on credit scores.

What kind of savings can a higher credit score yield for an individual?

The number that I have previously seen is that a 30 point increase in your credit score can decrease interest paid over a year by $105. Of course, over the life of a mortgage, small changes in interest rates can add up to big savings.

What should the account holder who is considering an authorized user know?

You are solely and completely responsible for the actions and debt of the authorized user to the credit card issuer as if you had incurred the debt yourself. High balances on the credit card could also impact the assessment of the primary accountholder’s credit availability.

If you are considering signing up to rent your credit score, among other things, you should consider the reputation of the service, potential identity theft problems, and whether you are protected from the user running up charges on your account.

Any downside for the authorized user?

Both good and bad credit history can flow to the credit report of the authorized user. If the account goes into default or collection, that information will be reflected in the authorized users credit score. But the individual can ask to be removed as an authorized user and have the information removed from their credit history. Of course, that will take time, and if you were renting the credit history and did not know the credit information, it’s unclear exactly how this would be accomplished - though I’m sure a system could be put in place.

If you are considering paying a credit repair firm for a quick fix, you’ll have to weigh, among other things, the cost, the potential that the credit score piggybacking won’t have the desired effect, and the reputation of the credit repair agency.

Will credit repair agencies return to credit piggybacking?

That’s anyone’s guess. Since there is alot of money in fixing bad credit scores, the answer is probably yes. It seems likely they’ll test the system and figure out if they can get around the FICO credit score safeguards.

What would the FICO model likely look for in order to differentiate legitimate authorized users from intentional tampering?

These are just speculative, but I would guess they would examine these four characteristics:

• Family Relationship - Of course, in a Bankrate article, the writer posed the question of whether users could game their credit score through an authorized user account on the credit card of a family member with a good history and the answer was no.

• Geographic Proximity - One way to determine whether authorized users are strangers.

• Use of Credit Line by Authorized User - Credit repair occurred anonymously and did not provide for the user to use the account holder’s credit line.

• Multiple Authorized Users - If you’ve authorized more than one non-family member, that may be considered evidence of credit score piggybacking.

Two other considerations worthy of note for those considering it:

• Decreased Impact on Credit Scores - Fair Isaac may have downgraded the impact of authorized user accounts in order to discourage credit score piggybacking providers.

• Opt Out - Fair Isaac may allow lenders to see the credit rating without the impact of the authorized user accounts.

DISCLAIMER. This is NOT legal advice and is NOT a recommendation that you engage in this activity. Use at your own risk.

More Reading:

Recent News Articles:

• USA Today - Authorized-user credit card plans can be useful, and abused
• Hartford Courant - ‘Authorized Users’ Back in FICO Score
• Bankrate - Authorized-user accounts OK again
• Baltimore Sun - Thumbs up for FICO revision

Recent Blog Discussions:

• Lenderama - FICO to Restore Authorized User Accounts
• Mrs. Micah - Finance for a Freelance Life - Now Being an Authorized User WILL Get You Credit Scores Again
• Choice Finance - FICO score changes in 2008
• Yielding Wealth - FICO Backtracks on “Authorized User”

Older News Articles:

• Bankrate - Dangers of being an authorized user
• Marketwatch - No Free FICO Rides
• Chicago Tribune - Credit-boosting shortcut fades fast
• Washington Post - Reprieve for the Piggybackers
• Washington Post - Piggybackers Take You for a Ride
• Bankrate - Piggyback can lift your credit score

Older Blog Discussions:

• Phoenix Real Estate Guy - Buying a Higher FICO Score?!?
• My Money Blog - Got Good Credit? Rent It Out For Cash!
• Work at Home Business Opportunities Weblog - Rent Your Credit Rating?

MasterCard spent $1.1 million lobbying in the second quarter of 2008 on, among other issues, the new credit card rules proposed by Congress and the Federal Reserve, according to Forbes.  MasterCard’s credit card lobbying efforts cost it $720,000 in the first quarter of 2008.

The United States isn’t the only country where consumers are having difficulty with credit card debt and rising expenses.  I previously discussed the problem with credit card debt in Great Britain.  And numerous news stories have focused on the growing problems with credit card debt in other countries in the world.

Australians owe a national record $44.2 billion in credit card debt, up 3.5% since December.  The average credit card debt for a family in Australia is $3200, with typical interest rates ~ 20%.

Credit card spending in Korea in July was up 22 percent compared to July 2007, due to both an increase in the popularity of credit cards and a 6 percent year over year increase in consumer prices.

And Turkey’s problems with credit card debt were recently chronicled by the New York Times.  As the NY Times said, ” Few American exports have proved as popular as credit cards.”

Connecticut is suing three credit rating agencies alleging that the rating agencies gave artificially low rates to municipalities, causing them to pay higher interest rates on bonds.  Read more about it here.

I wonder if consumers who believe that they have been unfairly denied access to lower interest rate credit cards and debt could sue under a similar theory?

Credit raters have been the subject of investigation and litigation concerning their role in the subprime crisis.  I think it is pretty universally accepted that they dropped the ball on their rating of mortgage backed securities.  But the question of whether they can be held liable for their credit ratings is an entirely different question which will probably be extensively litigated in the years to come.  If corporate plaintiffs are successful in holding a credit rating agency liable for a high rating upon which they relied, consumers may get the ammunition that they need for unwarranted low marks.  However, credit raters could argue that there is a substantial difference between debt buyers and credit seekers.

That’s what makes the Connecticut lawsuit interesting.  Connecticut is essentially a consumer in these transactions, and a beneficial ruling could aid consumers seeking to challenge the cost of their low credit score.  While it might not make sense for an individual consumer to bring a lawsuit, the cost of an artificially low credit score across a large group (say 30 points low) could raise the cost of carrying debt by billions.  If you could boost your credit score by 30 points, you would save an average of $105 a year - and if all Americans were to boost their credit score by 30 points, Americans would save $28 billion collectively.

I recently stumbled across an article about a South Africa company introducing a cell phone based payment system to Cape Town, South Africa.

It’s got me wondering whether this type of mobile payment system will catch on in the United States.  While it would be nice to simply carry my cell phone rather than my wallet, I expect that it will take awhile for general acceptance. And until a system is created to carry my driver’s license on my cell phone, and I don’t feel the need to carry some emergency cash on my person, it is really attempting to solve a problem that I don’t have.

I wondered whether cell phone payments had been tested in the United States and after a little bit of research I discovered that a wireless payment sytem was tested in the Washington DC area in 2006 (explained here). It involved using an Radio Frequency Identification chip (RFID) in the cell phone to store credit card and bank information, which was read by a scanner at the check out counter. Major League Baseball has implemented a similar system to allow baseball fans to receive baseball tickets on their mobile phone and enter the park by displaying and scanning a bar code on the cell phone. Now that is something that I expect to catch on.

This Bankrate article from 2005 predicted that cell phone based payment would be a growing method in 2006-2008.  And while gas stations now frequently offer contactless transactions for those on the go, I don’t think it is nearly as popular as the author in the article would have predicted

But digital payment companies, such as Paypal and its competitors, are moving into the mobile payment space.  They are enabling persons to transfer money between cell phones numbers and authorize the payment of money through text messaging. As cell phones move to replace (or at least substitute themselves for) desktop computers and televisions as entertainment devices, there’s no reason that they couldn’t replace credit cards as well as the public becomes more comfortable with the technology and retail establishments begin to accept them.

What do you think?  Will cell phones make plastic credit cards obsolete?

Credit card companies have pretty much always felt free to adjust the interest rate on their fixed rate credit cards. That is, until last year when Citibank decided that the fixed interest rate on its credit cards would no longer be increased at any time for any reason. Citigroup has since rethought that policy, and now it turns out that Discover has also had its fixed rate credit card policy under consideration.

An NBC affiliate reported that Discover Card has informed holders of its fixed rate credit cards that it is converting them to variable rate credit cards. The conversion will take place on October 1, 2008. I haven’t determined yet how many Discover Card holders are receiving the notice of the change in policy terms.

The report is concerned that variable rates will increase the amount of interest that credit card holders pay and could kick start credit problems among some who cannot convert to another fixed credit card and are forced to accept an increase in the interest rate on their credit card.

I am going to hold off on judging the effect of the conversion from a fixed rate to a variable rate by Discover. Since fixed rate credit cards have recently operated almost as variable interest rate cards, it’s not clear what will be the short term impact on the interest rate of card holders. The concern with variable interest rates is that an affordable debt obligation could become unaffordable as interest rates increase. But as long as the Federal Reserve continues to keep interest rates low, consumers might even benefit from a floating rate.

The conversion by Discover also ends the doublespeak on interest rates that has surrounded changes in interest rates on fixed rate credit cards. That, in and of itself, is a policy change to be celebrated.

In these days of increasingly tight credit, credit card companies are still targeting college students and potential first time cardholders for credit card offers. One study found that 33% of 2007 college graduates had credit card debt from college exceeding $5000. It’s gotten so bad that even a 4 year old girl was recently preselected for a Capital One credit card.

Credit card companies argue that college students handle credit as well as the general population, but it may be simple economics. The costs of acquisition of new debtors while in college are low, there is often strong brand loyalty from college students toward the company that provides their first credit card, and parents often bail out their debt burdened children when they get in trouble.

It’s an issue that has gained increasing attention as Congress considers reforms for the credit card industry. Some colleges have sought to prohibit marketing to their college students. But other colleges have profited from the exploitation of their students by the credit card providers. In fact, some estimates are that colleges and universities in this nation receive more than $1 billion from deals with credit card providers. State representatives in Ohio have introduced legislation to prohibit credit card marketing on Ohio campuses and universities. It’s also been subject to examination by Congress.

Some experts argue that what is needed is more education about finances and credit cards for college students. But those that have studied prior education efforts to promote financial literacy doubt its effectiveness. This Chicago Tribune article argues that financial education classes are ineffective and potentially counterproductive by giving graduates a false sense of security when entering financial transactions. They say there’s simply no evidence that education works and are fearful that the Congressional response will be limited to more education.

One good aspect of the suggested Federal Reserve credit card reforms was that they began from the presumption that more disclosure wouldn’t help. It seems to be implicitly recognize that education on the policies of credit card companies wouldn’t work.

But the issue of credit cards and college students has gotten more important over the last year as the credit crisis has tightened the availability of private student loans by college students. The increasing cost of tuition and limits on public assistance has, in the past, forced many to turn to this source for additional money for college and graduate school. Private student loans typically account for 25% of student loans. But with tightening credit standards and banks ending their private student loan programs, as well as the difficulty that parents will have in tapping into what is left of their home equity through loans, college students may be forced to choose between charging some portion of their tuition to their credit card or halt their college education to earn more money. Already, 24% in a recent survey indicated that they had charged part of their tuition to a credit card. That percentage seems likely to grow. It will also probably increase the average credit card debt of graduating students, which is already averaging $2000 - $3000. And that debt will be at a higher interest rate than typical student loans, without the offering of deferment or forbearance for those in school or unemployed.

It will be interesting to see how these issues play out over the next six months as the first college students face the credit crunch - whether states, federal programs, and other lenders step up to fill in the gap - and how Congress addresses the issues of credit card marketing.

Read more about the student loan crisis:

• Paying College Tabs as Loans Dry Up - CBS News
• Students Face Hit As Private Lending Dries Up - WSJ