Discover Under Fire for Payment Protection Plan

In addition to a slew of class-action lawsuits, Discover will also face scrutiny from the FDIC over its controversial payment protection plan. In its first-quarter 10-Q SEC filings released on July 1st, Discover admitted that the FDIC was investigating its “marketing practices with respect to its fee-based products, including its payment protection fee product, which could lead to an enforcement action.”

The product: defer your payments, but at a cost
Discover bills its payment protection service as a way to avoid credit card payments for two years (adverse events) or one month (“celebration” events). Discover cardholders can sign up to put off credit card payments for 24 months in the event of unemployment, disability, leave of absence, death of a close relative, disaster or hospitalization. They can also defer for one billing period for a handful of positive events, including childbirth, marriage and graduation.  The card balance doesn’t accrue interest or late fees during that period.

The protection, however, comes at a cost. Not listed in the frequently asked questions, but mentioned in the disclosures, is the monthly fee: 89 cents per $100 of the deferred balance. While the amount may seem negligible, taken over a year, it amounts to 10.7% of the balance. This is effectively a 10.7% interest rate on the unpaid balance, although it does not compound like a traditional APR. If the balance is deferred because of a hardship event, the card becomes unusable during the payment protection period. Fee products, including payment protection, earned $105 million in the first quarter of 2011, up 4% from last year.

FDIC and lawsuits allege deceitful marketing practices
According to the New York Times, a class action suit filed in New Jersey alleged that Discover used deceptive marketing techniques to enroll cardholders in payment protection programs. Lawyer David S. Paris said that many cardholders were unknowingly enrolled while discussing another matter with a card agent, while others were enrolled without their consent at all. “Even if you tell them you are not interested, they…basically disregard your rejection and enroll you unilaterally,” he said. The suit further charges Discover with having “onerous” requirements to cancel the plan and not properly disclosing fees.

A search for “Discover payment protection” yields, after reports of the company’s stock falling 2% following their SEC filings, a litany of complaints from consumers arguing that they were “snookered” into the plan or unable to get out of it.

“We are committed to providing quality products that offer real value to consumers and marketing them clearly and transparently,” said Discover spokeswoman Leslie Sutton, who said that the company is engaging in “constructive dialogue” with the FDIC.

According to the SEC filings, the eight class action lawsuits over the product were consolidated into one case with the US District Court in northern Illinois. All eight suits, filed across the country, ask for “unspecified damages and restitution, attorneys’ fees and costs, and various forms of injunctive relief including an order rescinding the payment protection fee.” In June, Discover reached a settlement with all parties that is pending judicial approval.

In another suit filed in December of 2010, the Minnesota Attorney General alleged that Discover’s enrollment tactics violated state law. Discover, say the filings, “will seek to vigorously defend all claims asserted against it.”

Alternatives to payment protection
A Discover cardholder can avoid the unnecessarily high 10.7% annual charge for payment protection. Depending on the amount of time you want to defer, he may be better off with a balance transfer credit card that charges a 5% fee but will not accrue interest for an extended period of time. The Citi Platinum Select Card (from MasterCard) offers 0% interest on both balance transfers and purchases for 21 months, with the added benefit of not suspending card use during that period. If you defer for less than 6 months, avoiding the balance transfer fee makes the payment protection plan worthwhile. However, if you’ll defer for more, the savings on zero interest balance transfers will outweigh the cost of what amounts to interest on the payment protection plan, even with a 5% balance transfer fee.

Credit unions often waive the 5% balance transfer fee, and while many do not offer 0% interest periods, a number have low ongoing balance transfer offers. First Tech Federal Credit Union offers no balance transfer fee and 3.99% APR on transfers for 12 months, which amounts to about a third of the Discover plan’s fees over the same period. Pentagon Federal has a lifetime balance transfer interest rate of 4.99%, useful for cardholders who may experience hardship longer than the Discover plan allows. The best balance transfer deal comes from Navy Federal, which charges no balance transfer fee and no interest for 12 months. However, you or a family member must be a member of the military or Department of defence to join.

Tim Chen is the CEO of NerdWallet, a credit card website dedicated to helping consumers find the best in low interest credit card offers.

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