Subprime a term with many shadings; what does it mean to credit unions?

ARLINGTON, Va. – As regulators have begun to focus steadily more attention on what has been described as predatory lending and as the Fed has begun to crack down on what are considered “subprime” credit card issuers, more attention has been focused on just what the term “subprime” means. Unlike what a lot of people suppose, subprime does not automatically mean predatory and does not automatically translate into abusive or unsavory practices, according to Colleen Kelly, CUNA’s Vice President of State Government Affairs who tracks the issue for the association. Credit unions need to be aware of how the terms are being used and what they mean because of lot of what credit unions do involve loans that could be considered “subprime,” Kelly said. Working with borrowers considered subprime can be a significant part of the way credit unions reach out to lower income and previously underserved members, she added. As a term, subprime is fairly easy to define. According to CUNA’s definition, which is fairly accepted around the industry, “Subprime lending involves loans to persons who do not qualify for a financial institution’s `prime’ rate because of a poor credit history, or simply the lack of a credit history.” A prime rate is usually the lowest rate of interest a financial institution offers to its best customers for short term unsecured loans, the association said, and subprime loans are offered to consumers at a higher rate of interest, which off-sets the higher risk of lending to consumers with poor credit histories. CUNA differentiates between “fair subprime loans” Kelly said, which are not structured in a deceptive and disadvantageous manner, and “predatory lending” which is characterized by particular practices. Fair subprime lending is a necessary tool that credit unions need to have available to help their efforts to reach out to low-income populations. According to CUNA, predatory lending involves procedures like flipping, packing loans, and including undisclosed balloon provisions in the loan. Flipping is the practice of convincing a borrower to finance and refinance their home over and over again, at each “flip” paying a steadily high fee for the transaction. Lenders “pack” loans when they fill them with additional insurance premiums and other fees, often for insurance the borrower does not even know they have purchased. Balloon provisions in a loan are those that require a large payment after a given number of years. In a predatory situation consumers are not warned of these provisions and often have to refinance. By contrast, CUNA said a fair subprime loan is one that can actually help the borrower move to a condition of better credit with a lower interest rate through a variety of means. For example, the $453 million Aberdeen Proving Ground Credit Union has a “Credit Builder” program designed to help borrowers improve their credit standing. “Credit Builder” offers subprime loans at 2% or 4% above normal rates, depending on collateral, but these higher rates automatically drop when the borrower makes 12 on time payments. “In this program, the borrower is well informed that if he or she has one payment that is over 30 days past due any time during the first year of the loan, then the borrower is locked into the higher rate for the life of the loan,” CUNA noted. “But, if the borrower makes the first 12 payments on time, the loan rate will automatically drop to the prime rate.” Missing a payment as well will hike the rate again, according to the credit union. The definition of what makes a for a subprime loan in credit card lending is a little different, but usually relates to credit scores or a lack of credit overall, said one analyst for the Federal Reserve who said rules prevent him from speaking on the record. Like predatory lending, he said, the business of issuing so-called “subprime” credit cards have been characterized by certain procedures that, he said, have often taken advantage of consumers and have actually resulted in “junk” credit card portfolios. Five federal financial regulators, the Office of the Comptroller of the Currency (OFF), the Federal Reserve (FED), the Federal Deposit Insurance Corporation (FDIC) and the Office of Thrift Supervision (OTS) have issued draft guidelines for how credit cards are to be marketed. The industry has widely perceived the guidelines as targeting firms that specialize in issuing subprime credit cards and they provide a window into the type of tactics some credit card issuers have used, the analyst said. For example, the draft guidelines instruct issuers that the regulating agencies “expect institutions to manage credit lines conservatively, using proven credit criteria and a sound process that includes testing, analysis and controls.” Specifically the agencies said “institutions have granted additional cards to borrowers already experiencing payment problems on existing cards.” The agencies also cited issuers for account management practices that did not control purchase authorizations adequately. [email protected]