Remember Mom’s department store credit card? High APR, low credit line, good only at the store? It’s back.
As of April 29, Target no longer issues Target-branded Visa cards; customers who want to open a credit account at the store will be issued Target store cards, usable only at Target stores or Target.com.
Now, to be clear, Target will still be accepting Visa, and existing Target Visa cardholders will keep their cards. So what’s the big deal? The explanation, be forewarned, involves the S-word.
A Clever CARD Act Loophole
Have you ever wondered how much retailers make on credit cards? When you sign up for a Target card, it’s issued by the retailer’s own Target National Bank. (No, seriously!) Target grosses over $1 billion per year on finance charges and late fees alone. Notice I said “grosses”; more on this in a minute.
Retailers would like everyone to buy on credit. If customer has a low credit score, no problem: traditionally, that person is charged a higher interest rate to cover the risk.
Here’s how it used to work: “People that weren’t able to get Visa cards a lot of times started out with the store card,” says Kit Yarrow, consumer psychologist and professor at Golden Gate University. “[The store card issuers] reduce the risk by charging more interest and assuming some people aren’t going to end up paying. Some people who maybe couldn’t get credit somewhere else got a Target card and then became loyal Target shoppers, just because they didn’t have credit to shop anywhere else.”
Indeed, the Target Visa card carries an APR that’s 2% lower than the store card. Sure, that doesn’t sound like much. “On the surface it looks pretty meaningless, but it’s still pretty significant, if you start adding up the number of cardholders,” says Curtis Arnold, founder of CardRatings.com.
Target is experimenting with their credit card business because profits have collapsed. In 2007, the chain made $797 million on its card business. By 2009, that profit had dropped by three-quarters, to $201 million. The reason? People stopped paying their bills. Target has had to write off over $1 billion in bad debt two years in a row.
At the same time, the Credit CARD Act, which went into effect this year, makes it hard for retailers to deal with this in their traditional way, which is to jack up interest rates on the total balance for customers who are still making payments.
Target says as much in their 2009 annual report: “The recent Credit Card Accountability, Responsibility and Disclosure Act of 2009 has significantly restricted our ability to make changes to cardholder terms that are commensurate with changes in the risk profile of our credit card receivables portfolio.”
Creeping Towards Subprime
So Target is making a gamble: give every new customer who opens a credit account the Target card. Which, by the way, currently has a 25.24% APR and a tiny minimum payment of 1% plus interest. This is creeping toward the terms you see on cards that serve a particular market, the S-word I was talking about earlier: subprime. “There are certain banks that tend to play in that space. I wouldn’t call it subprime, but let’s call it the FICO scores that aren’t stellar,” says Dennis Moroney, an analyst at market research firm TowerGroup.
“I wouldn’t go so far as to call it subprime,” agrees CardRatings.com’s Arnold. “It’s more of a near-prime card.”
Remember, this is for all new Target credit customers, not just the ones with mediocre credit scores. Charge $1,000 on that card and pay the minimum, and you’ll be out a total of $2,402 until you pay it off in 10.5 years. Incidentally, thanks to the Credit CARD Act, information about the minimum payment will appear in a box on your bill. (You can calculate how long it will take you to pay down your debt using this calculator.)
Of course, that’s not how Target explains the move. As a spokeperson explained to me, the company did a study in which some customers who would have been issued Visa cards received store cards instead. Those customers averaged more visits to Target stores and spent more money than the Visa cardholders.
Target is also experimenting with its rewards program. The current deal is, once a Target cardholder racks up a certain number of reward points, they get 10% off on a single day’s shopping at Target. The chain is testing a new regime which would offer Target cardholders 3% or 5% off at all times.
As consumers rouse themselves from the recession, Target wants to “catch the economy on an uptick,” Moroney says. “There’s got to be a lot of pent-up demand. I mean, things don’t last forever. People like big-screen TVs and so on.”
Credit customers are hugely important for Target and its competitors. “The retailers are looking how to drive sales up, and you can do that with credit,” says Moroney. “I expect to see more merchants doing this–the big ones, anyway, the Walmarts and so on.”
Will Target’s Move Backfire: For The Retailer or Its Customers?
Arnold is skeptical that anyone will want to carry both a general purpose credit card and a Target card. “I’m afraid it’s going to backfire to some extent on them,” he says. “These cards are kind of dinosaurs.”
Should anyone carry the Target store card? I could see it working out for customers who spend a lot at Target and never carry a balance, since in most cases a single month of interest would wipe out any reward discounts.
But Target is betting heavily that Target card customers will revolve credit–that is, that they’ll eventually pay up to double the sticker price at Target stores for the privilege of borrowing a little of Target’s money. Membership has its privileges. I guess.