Evaluating the CFPB’s Proposed Rule Change Regarding Independent Income & Credit Card Applications
As many of us know, the Credit CARD Act of 2009 contained an ability-to-pay provision requiring credit card issuers to evaluate whether applicants will be able to make monthly minimum payments in light of their independent income and debt obligations. The rule effectively put an end to long-held practice of allowing applicants to use household income, which made underwriting difficult given that it was impossible to know how much of this income was actually committed to debt obligations held by other members of the household. While the rule change therefore curtailed unnecessary overleveraging, it also made it more difficult for stay-at-home spouses to both access and build credit independently.
In response to the resulting consumer backlash, the CFPB has reversed course, proposing to “allow credit card applicants who are 21 or older to rely on third-party income to which they have a reasonable expectation of access.”
So, is this change a good idea? Well, it certainly has it's pros and cons, as you can see below.
- Easier for Stay-at-Home Spouses to Access Credit: Without sufficient independent income or assets, stay-at-home spouses are forced to rely upon joint credit card applications in order to build credit in their own names. Having a strong independent credit score is extremely important in the event of divorce or the death of a loved one because one’s credit standing dictates not only the loan and credit card terms they can qualify for, but also their insurance premiums and ability to lease a car, obtain housing, or even land a job.
- Promotes equality in the household: Whether it is a man or a woman serving as a stay-at-home spouse, they want to have equal rights with their significant other. That means one party should not be able to apply for a credit card without the other’s knowledge, but not the other way around.
- Illustrates CFPB Dedication to Consumer Interests: The CFPB has clearly taken its role as a consumer advocate seriously, and that should be comforting given the still-fresh memories many folks have of being taken advantage of prior to and during the Great Recession by issuers who engaged in shady tactics such as hair-trigger repricing and assessing overly-burdensome fees.
Undermines Underwriting: Third-party income to which you have a reasonable expectation of access is essentially just another way to say household income, which means the CFPB is simply hoping to revert back to the system that was in place prior to the Great Recession. However, there was a reason Congress made a change in the first place. When you allow a credit card applicant to list income that may or may not be their own, it is impossible for underwriters to determine how much of it is already spoken for and how much is actually available for new credit card payments.For example, imagine that a credit card company receives applications from the following two consumers:
- Consumer A: Lists $100k in income and $300k in debts
- Consumer B: Lists $0k in income and $0 in debts
Obviously, neither Consumer A nor Consumer B would get approved, regardless of whether they apply independently or jointly. However, if Consumer B is married to Consumer A and applies using their household income (Consumer A’s $100k), then Consumer B would like to issuers like someone with $100k in income and no debt and would most certainly get approved for a high line of credit. Therein lies the problem. The family still wouldn’t be able to afford this new line of credit and will ultimately default, the bank will end up losing money in the long term, and if this happens across the board, the entire economy would be put at risk.
In other words, allowing applicants to list shared income and personal debts is a recipe for disaster. Considering the rate at which we’re incurring debt now, the last thing we need is to open the floodgates by diluting the effectiveness of underwriting.
- Muddies the Regulatory Waters: Financial regulators have two clear objectives: 1) Maintaining the safety and soundness of companies and markets; and 2) Protecting consumers. As these are often competing interests, it is difficult for a single regulatory body to simultaneously fulfill both. The CFPB’s proposed rule change is a prime example of this, as the organization is jeopardizing the safety and soundness of banks and the economy in general in order to safeguard the interests of an extremely important consumer group.
Ultimately, the negative consequences of the Consumer Financial Protection Bureau's suggested rule change outweigh its benefits, especially since unexplored options yet remain. Instead of reversing course and allowing consumers to list shared income on credit card applications, the CFPB should first require that all credit card issuers accept joint applications. This would enable couples to apply together, listing both of their Social Security Numbers as well as their combined incomes and debts, thereby allowing underwriters to make truly informed approval decisions and giving both applicants the ability to build independent credit.
However, this change alone would be insufficient because it would still give the household's income earner power over his or her significant other in the sense that the former could apply for a credit card without the other knowing, but the latter could not. That is why secured credit card underwriting rules must also be adjusted. When it comes to secured cards, issuers are already protected from the threat of default by the fact that cardholders are required to submit a security deposit, which then serves as their credit line. In other words, if a stay-at-home spouse has enough personal money to make the requisite security deposit, they shouldn't need to also display the independent income required to make recurring payments. If they prove unable to pay off a balance, they simply will won't get back that portion of their deposit.
Combined, these two changes would solve the problem of credit inaccessibility for stay-at-home spouses without compromising the integrity of underwriting. The long-term benefits of this relative to the CFPB's proposed change would be more secure financial institutions, a healthier economy, and less credit card debt.