Coronavirus crisis plays to the strengths of secured credit cards

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With the COVID-19 health pandemic wreaking havoc on jobs, investments, consumer debt and lending, secured credit cards can address a vital need for people who may not have considered the product in the past.

Even before the coronavirus began its global spread, the secured credit card was already seeing something of a renaissance. Secured cards are designed for people with poor or thin credit, and require a security deposit to establish their spending limit. Because the borrowers were seen as high-risk, secured credit cards once had a shady reputation.

But secured credit cards found a clear niche after the CARD Act of 2009 established transparency mandates. The CARD Act also cracked down on the practice of offering credit cards on college campuses — a change meant to remove the lure of easy credit for undisciplined spenders. But it also removed an easy way for college students to establish credit early in their lives.

In recent years, issuers realized that many thin-file borrowers weren't as high-risk as the category once was — they simply didn't need credit or had no access to it until later in adulthood. These consumers were likely to be responsible cardholders.

By the summer of 2019, in a booming pre-pandemic economy, the market for secured cards had gotten competitive enough that Amazon launched its own Credit Builder Card that offered rewards on par with its mainstream private-label and open-loop credit cards.

Even though card-issuing banks and lenders have a lot on their plates in dealing with the economic fallout of the pandemic, the secured credit card market has remained stable and could be poised for positive growth, said Brian Riley, director of card services for Mercator Advisory Group.

"There are bigger segments to worry about because secured cards at least have balances behind them, so there is limited credit risk," Riley said. "Lenders are likely more concerned about your FICO scores under 650 or 680."

Many consumers find themselves using services such as no-contact food delivery — which, by their nature, are more conducive to card payments than cash or check — for the first time. So these consumers may need an easy way to start making card payments, and would turn to products like secured credit cards or prepaid cards if they can't qualify for a mainstream credit card.

Furthermore, the uncertainty of what COVID-19 will leave in its wake — and how it might alter the credit card landscape — positions the secured credit card concept as one that could operate as a "pandemic relief tool."

"Where are we when we get on the other side of COVID-19 and what do we do with 12% and 14% write-offs?" Riley asked. "There could be more secured cards than ever before as a result because people will still need cards and we aren't confident about employment. It makes it a good channel."

The process for opening a secured credit card is generally the same, regardless of the issuer or network. The borrower provides a security deposit, usually of a few hundred dollars, to act like an escrow account that determines the credit limit on the card. Some banks will include incentives for allowing the user to exceed a credit limit, such as paying close to the full balance on a monthly bill for six consecutive months.

"Instead of moving the cardholder to a 'pure' credit card, they might let that person go 50% or higher over the credit line, or something similar," Riley said. "Others won't trigger collection of payments for 60 to 90 days because the money is there in the security account."

Many issuers viewed it beneficial to serve a market that essentially calls for a cardholder to start slowly with a credit card product and then advance to unsecured accounts, more financial freedom and possibly long-term loyalty to the bank.

Secured credit cards work as a counteroffer after an application for another card is declined, as a vehicle to advance to beyond a prepaid card program, or for targeting specific market segments under specific terms. The protections under federal law, many of which do not apply to prepaid accounts, call for reporting accuracy, consumer protection and interest rate integry.

Once the cardholder has established healthy payment habits, the issuer may choose to graduate them to an unsecured card. Alternatively, other issuers may seek to poach the customer with their own unsecured credit cards.

Mercator Advisory Group estimated in December (before the coronavirus outbreak in the U.S.) that secured credit cards would see continued growth over the next few years. It cited 1.5 million secured credit cards in use in 2011 in the U.S., with that total nearing 5 million accounts by the end of 2019. The numbers were on a trajectory to hit 6 million by 2023, Mercator said.

With credit scores likely tanking for many consumers suffering from job loss, pay cuts or health issues, banks will have to determine which products might fit a current or post-pandemic consumer.

"There is a need for the issuers to provide some kind of leniency in the form of tacking payments on the back end of an outstanding balance or loan vehicle in order to allow a generally creditworthy customer to function and work through their tough economic situation," said Maria Arminio, president of Avenue B Consulting Inc., a Redondo Beach, Calif.-based payments management consulting firm.

In general, lenders are entering a period of time in which knowledge about the customer is "fueled by access to more data and it is going to make the difference on how the industry assesses creditworthiness," Arminio said.

A secured credit card could be a logical vehicle for those who are seeking more funding sources, mainly because those consumers don't want to dip into other savings and want to be more resourceful with financial tools available, she added.

The National Bureau of Economic Research's Business Cycle Dating Committee declared that in February the COVID-19 pandemic ended an historic 128-month cycle of economic expansion in the U.S. that began in 2009. It also affected consumer credit.

Since March 15, more than 42 million workers have filed for unemployment benefits, and many others are working fewer hours for smaller paychecks, the Consumer Finance Institute at the Philadelphia Federal Reserve bank noted in a report this month.

CFI analysis revealed credit card lenders' offers to new customers fell sharply in mid-March, around the time the U.S. issued national emergency declarations. However, new federal guidelines encouraged lenders to grant fee and interest waivers, payment deferrals and other forms of assistance, such as increasing rewards, to customers facing financial troubles.

It all creates an atmosphere in which secured credit cards could morph into a tool beyond their current status as a way to advance to an unsecured card and higher credit lines by becoming a way for a consumer to take a step back, assess a financial situation and work toward rebuilding credit scores and credit lines.

"A takeaway from all of this might be that as we go through the crisis, these cards are less risky because there is a balance behind them," Riley said. "It's probably one of the high-growth channels we will see as the economy recovers."

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