The profitable business of credit to subprime borrowers

For credit card issuers, lending to so-called “subprime” borrowers has become a source of income since the Great Recession.

Nearly 50 million Americans, including more than 30 million millennials, have poor credit and are considered “deep subprime consumers,” according to the annual consumer credit card report from NerdWallet, a website of. personal finances.

“There is a big difference between a credit score of 600 and 800,” said Sean McQuay, credit card analyst at NerdWallet. “Consumers with excellent credit have access to the best loan terms and the lowest insurance rates, as well as the most options. That’s the difference of thousands of dollars in interest charges per year.

It’s no secret that subprime borrowers face more expensive credit terms. While the average annual percentage rate for all borrowers is 18.2%, those with a credit score of less than 630 pay an average of 22.2%, according to McQuay.

This translates into more revenue for the card issuers. While fees are paid by credit cardholders across the board, interest is only charged to those with a balance, who are often cardholders with poor credit, according to a report by Consumer Financial. Office protection.

Interest payments made by all cardholders represent 80% of the total revenue card issuers receive from consumers, according to the CFPB report.

But while those who are considered blue chip borrowers typically pay off their debts, riskier consumers increased their card balances: to $ 5,063, on average, from $ 4,891 a year ago, according to a separate study by the credit reporting firm TransUnion.

As a result, card issuers continue to increase the availability of credit, especially for millennials and other consumers with lower credit scores. About 10 million new consumers entered the credit card market in the past year alone, the majority of whom were at-risk borrowers, according to TransUnion.

Although credit card use is on the rise, Jess Sharp, executive director of the American Bankers Association’s Card Policy Council, said this was the result of an improving economy and card debt. of credit remained manageable.

“As more and more consumers use credit cards for short-term financing, the amount of credit card debt they carry relative to their disposable income is quite low by historical standards,” he said in a statement.

For those who are just starting out or have low credit scores or a limited credit history, McQuay recommends opting for a secure card. Although these cards require a security deposit, generally In the range of $ 300 to $ 500, an amount that is usually equal to the credit limit, deposits are fully refundable when the account is closed or when the consumer switches to an unsecured card.

The advantage is that it allows consumers to access credit without the need for a co-signer while avoiding sub-prime issuers, which specifically market borrowers with bad credit and charge high fees and interest rates to mitigate their risk.

Many of the larger issuers offer secure cards, but they are not heavily marketed as they are not money makers for banks,Mcquay noted.

For those who want an unsecured card, McQuay advises consumers to choose one with a high limit rather than a low APR, with the goal of paying the bill in full each month to avoid interest charges. In this way, consumers can maximize their debt utilization ratio, which is the amount borrowed against total credit available.

Debt utilization ratio is an important part of a credit score, so having a high limit but maintaining a low balance can help consumers save on interest and possibly increase their points.

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