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Credit Card Industry Urged To Review Practices

Oct 13, 2007
Perhaps you have noticed the changes in the credit card offers you have been receiving. For instance, early this year Chase Card Services junked the two-cycle billing practice on their credit cards, where your average daily balance subjected to interest was calculated on the basis of two full cycles instead of only one billing cycle. If you are used to carrying a balance on your credit card, the two-cycle method results in greater finance charges to you, so this change should reduce your interest expenses. This is part of the credit card industry's response to increasing pressure from consumer groups and U.S. lawmakers for credit card issuers to stop what are called "predatory and abusive practices."

Last March, Citigroup decided to remove two practices that have been objected to: the increase in a credit card holder's interest rates and other fees, at the option of the bank, at any time for whatever reason, and the practice known in the industry as "universal default," which means that if you fail to pay a bill to any of your creditors (say, a mortgage payment or a utility bill) the interest rates on your credit card are immediately increased.

Just recently, in the first week of June, Bank of America and Chase bared comprehensive programs to help customers better understand how the terms and conditions on your credit card account operate in order to enable you to manage your credit cards better. These moves are certainly meant to please holders of credit cards, although the skeptical would see them as moves designed to avert government crackdown.

In response to a swarm of complaints about credit card issuer's practices, Congress has conducted hearings, and some bills have been introduced in the U.S. Senate and the U.S. House of Representatives, all aimed to stop perceived abuses. Realistically, however, other lawmakers are of the opinion that new laws through which to impose new rules on the credit card industry are not likely to pass this session. Some legislators believe new legislation is not the answer.

The realistic approach to reform may be the changes proposed by the Federal Reserve on credit card advertising, billing practices and updates. One serious proposal will be the first major revision on truth-in-lending guidelines in a quarter of a century. This rule requires of all lenders to give 45 days' notice on any interest rate increases (the present practice is 15 days) - credit cards included.

The Christian Science Monitor reports that an advocacy group identifies the worst practices among credit card issuers as follows:

Penalties for late payments or over-limit fees are immediately imposed, even in instances where payment to the credit card account is received just minutes after the specified cut-off time (usually 2 p.m.) on the due date. Interest rates on credit cards are raised for whatever reason, at any time the bank chooses to. Payments are applied to those balances on credit cards that are carrying the lower annual percentage rate (APR) and not to the highest. The problem arises from the fact that credit card holders use the same credit cards for purchases, cash advances, and to absorb the balances that have been transferred from other credit cards. These are distinct transactions involving distinct interest rates; for example, cash advances have high interest rates while transferred balances may have zero interest. Since payments made are applied to balances that have the lowest APR, those balances with higher rates continue earning interest and increase at a faster rate.

Banks use the "trailing interest" method, which refers to interest charged on your outstanding balance between the cutoff date of the last statement and the date your payment is actually posted into your credit card account. This is particularly true for credit cards that don't have grace periods.

Absence of an upper limit on fees for balance-transfers by a number of credit card issuers. When you transfer balances from other credit cards, banks typically charge a fee (some waive it, though) of up to 3 percent of the amount transferred, but there used to be a cap of about $50 or $75. Without that cap, if you transfer, say, $5,000 you stand to pay $150 in transfer fees instead of $75 on your credit cards.

Consumer groups view these credit card practices as indications of "gouging." The credit card industry thinks these restrictions serve to guide consumer behavior with respect to the use of credit cards and have also made it possible for them to enjoy the many advantages of modern credit cards -- which include no annual fees and average APRs that are lower than the prevailing rates of twenty years ago. In addition, credit card lending is now enjoyed by many more people whereas years ago only a privileged few could be approved for credit cards.

For you as a credit card holder, what will this all mean?

For now, if you have some issues that you'd like to take up with your credit card issuer it may be the perfect time to discuss those issues while they are under the microscope. They'll be more likely to respond favorably. For instance, if you feel you're paying too high an interest rate and you have a good credit score, this may be a good time to request a lower rate from you're the issuers of your credit cards. Chances are that they'll be more inclined to grant such concessions.

There are some things that the credit card holder should realize, as a business partner in the credit card industry. On the matter of universal default, for instance, this is actually a means which helps the credit card issuers minimize having to penalize good paying customers for the undesirable credit behavior of other holders of credit cards.

In the past, everybody paid the same rates on their credit cards, regardless of whether you had very good credit or a poor one. Because of improvements in credit scoring, the industry learned to measure credit risk and became better able to evaluate the probability of an account going sour. The credit card issuer now knows that some accounts have two times more risk than others. And its pricing follows that observation. It's no different from a mortgage: if you're a riskier mortgage borrower, you get a higher rate.

A credit card is revolving credit, and it is as if your loan is being renewed every time. You make payments on your balances, you borrow once more. When you decide not to pay one of your credit cards, you immediately make yourself a riskier debtor. It is for that reason that when the credit card issuer "renews your loan" for the following month, the issuer may increase interest rates, as already stipulated in the terms and condition of the Credit Card Agreement.

This is exactly the same kind of term that governs corporate lending, in small business lending, or for businesses in general. There is always a cross-default clause in all loan agreements where the terms state that the bank will monitor all of the borrower's debts, and if the borrower goes sour on anything, the lender can demand immediate payment or changes in terms, including interest rate. But it is only the borrower concerned that gets penalized, not all other borrowers. It is risk-based pricing and it adjusts to take into account the overall financial conduct of the specific borrower.

This also gives - or should give - the credit card holders the necessary inducement to be more conscious of managing their credit cards in a responsible manner. They should become more conscious of their credit score, of their credit history ... and more conscious of the fact that whilst they may have five creditors and ten credit cards, there is one number that summarizes their creditworthiness. If the credit card holder manages that number well, the benefits of good credit will be his.
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