Why the CFPB & Stay-at-Home Spouses Need to Go Back to the Drawing Board

If we’re talking about a common sense approach to finance – as is the motto of This That & the MBA – the Consumer Financial Protection Bureau’s proposed solution to the stay-at-home mom credit crisis certainly doesn’t qualify.  In fact, it might even create a rack of far more serious issues, such as a trend toward mediocre credit card terms and overall banking instability.

Do I have your attention yet?

Hopefully I do, even if you are a bit confused at this point.  A bit of background is obviously in order if you’re to fully understand the issue at hand, so here’s what you need to know.

Background

Back in October, a new rule originally set forth in the landmark Credit CARD Act of 2009 took effect, requiring credit card issuers to abandon the long-held practice of using household income to evaluate a credit card applicant’s ability to pay.  The rationale was that since applicants could list debts at the individual level, household income obscured underwriting efforts and made it possible for people to get high credit lines they couldn’t possibly afford.

For example, an applicant who lists $100k in annual income and only $10k in debts might seem like a great candidate, but what if all that income came from the applicant’s spouse and was already earmarked for other expenses?  That would paint an entirely different picture of the would-be customer, but the credit card issuer would have no way to tell.

That’s why legislators decided to change the rules.  However, the new individual-income system led to what CFPB Director Richard Cordray has called an “unintended consequence,” making it harder for stay-at-home spouses to access credit.  That’s no small matter either, considering that having an open line of credit in one’s own name is the most efficient way to build credit.  Your credit standing in turn affects not only your loan and credit card rates, but also your insurance premiums, housing situation, and transportation options.

In short, the inability for stay-at-home spouses to freely access credit throws off household dynamics in the short term and stands to increase the burden on divorcees and widows in the future.

A Problematic Solution

In response to the understandable outcry from consumer activists, the CFPB proposed basically repealing the aforementioned CARD Act rule by allowing people to list on credit card applications third-party income to which they have a reasonable expectation of access.  This proposal is open for public comment through June, so you should probably know why it’s a bad idea.

• Third-party income would prevent accurate underwriting:

  As explained earlier, the off-balance use of shared income and personal debts makes it impossible for underwriters to determine how much a given applicant can attribute to monthly credit card payments.  The corresponding need for guesswork naturally creates a system in which some already overextended people get approved for accounts, while others who are truly more deserving do not.  What’s more, because banks can’t determine which people should get the absolute best terms, more applicants wind up getting approved for something average.

• Banks would need to compensate for increased defaults:

  When people who can’t afford high credit lines get approved for them in increasing numbers, banks inevitably find themselves with more and more unpaid bills they can’t collect on.  That has a trickle-down effect, prompting new fees and putting downward pressure on rates and rewards.  It might even force banks to layoff some employees.

• It would put added stress on the economy: 

  By now, we’re all keenly aware that when big banks suffer, so too does the overall economy.  It’s therefore in our best interest to avoid adopting new rules that would unnecessarily hamper the banking industry’s soundness and security.

A Preferable Approach

It would be one thing if the CFPB’s proposed course of action was the only one available, but there are indeed viable alternatives.  I, for one, suggest a two-part fix that would:  1) require card issuers to offer joint applications; and 2) eliminate income verification for secured credit cards.

Joint applications enable couples to apply for a shared account using their combined income and debt.  Since each party also lists their own Social Security Number, both people are able to build credit under their own names.  Many issuers already offer joint applications, but everyone must do so or else stay-at-home spouses will be at a disadvantage in terms of selection.

There is simply no need for income verification with secured credit cards since users are already required to place a refundable security deposit that acts as their credit line, preventing overspending and protecting issuers.  Eliminating that requirement would enable any stay-at-home spouse who has at least $200 (the standard minimum deposit) to open a card and independently build credit.

Together, those two steps would theoretically make everyone happy.  And considering how admirably the CFPB has conducted itself thus far, there’s probably a good chance its leaders will eventually wake up and smell the coffee.  But we’ll just have to wait and see.

Odysseas Papadimitriou is CEO of both the credit card comparison website Card Hub and the personal finance social network Wallet Hub.

Photo by: mike and steph boyle