Instant in-store credit card offers -- you know, the ones pitched by perky sales clerks offering 15 percent off your purchase if you sign up now for a store credit card -- may disappear in malls and retail outlets across the country come February.
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That's because a provision in the new credit card reform law says that starting Feb. 22, 2010, credit card issuers must consider an applicant's ability to repay the card loan before issuing a new card or increasing the credit limit on an existing account.
The measure has thrown a speed bump into the instant credit approval process and has the retail world in an uproar. Some of the biggest names in retail -- Saks Fifth Avenue, Macy's, Best Buy and Lord & Taylor -- are objecting to new guidelines proposed by the Federal Reserve Board. If given final approval, they say, it could kill the retailers' lucrative in-store instant credit card plans.
A speed bump to instant credit?
"We think it's pretty serious," says Mallory Duncan, senior vice president and general counsel for the National Retail Federation trade group. The Fed wants to require lenders to review income or asset information -- such as paycheck stubs or investment statements -- of people applying for new credit cards. The problem: Instant credit won't be so instant if consumers must fork over paycheck stubs at the cash register (known in the industry as the point of sale).
"My guess is most people don't walk around with either a pay stub or financial information in their purse," Duncan says. "In an effort to achieve one goal, the Federal Reserve Board may be inadvertently issuing consumer unfriendly regulation."
Macy's and other stores claim the restrictions could impact consumer spending at a time when the country is trying to pull itself out of a recession. Retailers have other reasons for concern. Data compiled by The Nilson Report, a payment card industry newsletter, show store credit cards were declining long before the new credit law. Outstanding balances on retail store cards -- known in the industry as private label credit cards -- have been falling as a percentage of total credit card balances for nearly two decades -- from nearly 24 percent in the early 1990s to about 11 percent in 2008, according to Nilson.
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Some shoppers are shunning store cards -- which typically limit customers to spending at a single store chain -- and opting instead for general purpose credit cards that carry the Visa or MasterCard logos and can be used anywhere those brands are accepted. Store cards have historically had higher default rates and cardholders with lower credit scores than general purpose cards.
How instant credit works
Currently, many stores require sales clerks to ask if shoppers have store credit cards. If they don't, the smiling clerk makes a pitch to sign customers up for cards -- sometimes with the inducement of getting 10 to 15 percent off that day's purchase, or, if online, getting free shipping or a gift card. If the customer agrees to get the card, they may be given an application form to fill out. Some stores have computer terminals set up to allow customers to input personal data: name, address, date of birth and Social Security number. In other stores, customers may be asked to fill out paper application forms, which are used by store personnel to input data into a computer.
With the click of a button, the application is electronically sent to the credit card bank used by the retailer or directly to a credit reporting agency (Experian, Equifax or TransUnion). Within seconds, a credit report and credit score is generated for the customer, and the bank sends an approval or denial of the application to the store. If approved, the customer's purchase goes through as the first charge on the new credit card account. The actual card is mailed a few days later, along with the credit card agreement outlining the terms and conditions of using the account. If there's a problem on the credit report, such as a history of paying bills late, bankruptcy, charge-offs or debt collection activity, the application is denied and the customer may be asked to provide additional information, such as bank account numbers or proof of income.
Under the Fed's new "ability-to-pay" rule, there could be an additional step that would take the instant out of instant credit. "A card issuer has not complied with this provision if, for example, a card issuer does not review any information about a consumer's income, assets, or current obligations, or issues a credit card to a consumer who does not have any income or assets," according to the Fed.
That could mean customers may have to hand in a pay stub or some other proof of income or assets along with the initial credit card application. Stores would have to figure out how to scan this information into their computer systems and how to evaluate the customer's ability to pay based on that documentation.
Another potential problem: Customers who deliberately lie about their incomes, either because they are embarrassed to reveal it to store clerks, want privacy or want to overstate their income in hopes of improving their chances of getting a credit card. Currently, annual household income is a standard question on credit card applications. This amount is self-reported and not verified.
Duncan from the retail federation argues past credit history is a better predictor than income of how customers will repay credit card loans. Income becomes more important for big ticket items such as homes and cars, he says.
"An applicant's credit history demonstrates a consumer's commitment to meeting their financial obligations," Steven Franks, Macy's senior counsel wrote in the comments filed with the Fed. "Their ability to properly budget for monthly expenses is indicative of their ability to make at least their minimum payments. This type of evaluation is more revealing to a credit card lender than asking an applicant for an unverified income amount."
The proposed rules may also create new roadblocks for stores hoping to increase credit limits on existing accounts. Duncan gives the example of a customer with an $800 credit limit on a Saks credit card who wants to buy two suits that cost of total of $900. The store can run a credit check, look at the customer's past payment history with the store and instantly approve bumping the credit limit up to $1,000 to accommodate the sale. Under the proposed Fed rules, the clerk would have to ask the customer for income information.
"Most consumers would find that conversation, if not intrusive, then distasteful while standing in line," Duncan says.
He adds: "We're not in the position that we want to alienate good customers ... Very few merchants are going to want to have that conversation. You want to have as few negative conversations with your customers at the point of sale."
Consumer group: Instant credit fuels impulse buying
Consumer advocates and credit counselors who coach people out of mountains of debt say making it harder for people to get credit cards while shopping is a good thing. It may cut down the number of people who get into trouble with compulsive buying.
"The risk of instant credit is impulse borrowing," says Gail Hillebrand, financial services campaign manager for Consumers Union, the nonprofit owner of Consumer Reports Magazine. "Instant credit is generally not a good idea for consumers. Other people can get it pretending to be you, which creates a mess for you."
Hillebrand says consumers with decent credit scores likely have the ability to pay. "If can you afford to make the payment, you probably already have credit available to you. In that case, you can use another credit card. There's no huge benefit of instant credit for consumers. It's retailers that need instant credit -- not consumers."
Duncan from the retail federation acknowledged that retailers will lose out if instant credit is curtailed. "These customers are typically more loyal to the stores," Duncan says, adding, "There are advantages to both the retailers and the consumers in this."
At Lord & Taylor, the high-end retail store, 40 percent of its $1.1 billion in customer sales is conducted with a Lord & Taylor credit card, according to comments filed by Christopher Sim, the company's senior vice president and CFO. Similarly, Belk, a department store chain that operates in 16 states, predicted a sales hit.
"The ability of customers to purchase on credit is critical to our retail sales," wrote James. A Ward, Belk's vice president of credit. "In these tough economic times, we simply cannot afford for credit to become less attractive or more cumbersome to obtain, and we expect this income requirement to have a direct impact on our sales."
As an alternative, several retailers have suggested that the Fed modify the rules so that opening credit card accounts with small credit limits -- perhaps $3,000 or less -- would be exempt from income review requirements.
Hillebrand from the consumer group agrees a low credit limit account may not warrant a review of income data. "They certainly could start you off with a very low credit limit," she says. "If you want more, fill out the form and tell us all this other information."
Credit bureaus offer solution
Experian and Equifax -- two of the three major credit reporting agencies (TransUnion is the third) -- have launched services in recent weeks they say will help retailers and other lenders assess borrowers' ability to pay in the same amount of time it currently takes to pull a credit report. Called income-estimation modeling, the programs rely on statistical analysis of databases of financial data to estimate a credit card applicant's income and assess their ability to pay loans.
Experian's Income Insight tool uses verified financial information from the IRS and other sources and links it to the credit bureau's database of millions of consumers, says Brannan Johnston, Experian's vice president of income and deposits. He says the model assesses the likelihood that applicants can pay based on verified income from the databases and on outstanding credit balances, available lines of credit, how long they have had credit, the sizes of their mortgages and whether they've ever missed a payment.
"For those lenders that ask income on an application, Income Insight can be used for income verification," Johnston says, noting that because the program is a statistical model, it is not used as the sole basis for declining an applicant. People who are deemed unable to make payments by virtue of the model would be asked to submit pay stubs or other proof of income before they could get loans.
Equifax announced on Dec. 8, 2009, it was expanding its ability-to-pay services to include tools that use IRS, employer and other databases estimate personal income. "By combining the predictive power of modeled financial measures, such as income, with the accuracy of bureau data and verified income, credit issuers have additional options to minimize risk and assess consumer ability and willingness to pay," according to an Equifax statement.
Representatives from Experian met with Fed officials in November to brief them on how the income estimation tools may help lenders meet the ability to pay requirements.
The Fed is reviewing the comments submitted on the guidelines and must issue final rules before the Feb. 22 effective date of the credit card law. A Fed representative would not comment on whether the ability to pay rules will be revised based on the retailers' concerns or if the income estimation modeling tools would satisfy the Fed's requirement for assessing ability to pay credit card loans.
What will retailers do?
Duncan from the retail group says if the Fed doesn't revise its rules, some retailers may be forced to back away from instant credit offers.
"Some will try, in some of their stores, asking for financial information at point of sale," Duncan says. "If the reaction is negative, it will go away. In the short term, it will dry up a lot of very good deals for consumers."
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