December 06, 2007

CREDIT CARDS ('Risk-Based Re-Pricing')

Congress has been talking about revising current regulations surrounding credit cards for several months now. Some members of Congress are being very vocal about current practices in the credit card industry (practices described by one critic as “abusive and confusing”). You’re likely aware of one common practice referred to as ‘universal default clause’ – a provision in a card agreement that enables the cardholder to raise your rate if you miss a payment to anyone [doesn’t need to be that particular card]. Universal Default is a concept I’ve outlined in prior tips on card management.

Earlier this week I read about a Senate subcommittee scrutinizing a newer practice that was being called “risk-based re-pricing.” Ultimately, this takes universal default one step further. The idea behind universal default was to raise the interest rate because of the increased risk placed on the card company; with risk-based re-pricing, rather than raising rates due to missed payments, rates can be raised in any circumstance where your credit score is lower than it was when they initially gave you the card. Keep in mind that 30% is commonly the rate charged when one’s rate is raised! Obviously the high rates were of concern to the subcommittee, but they were also concerned about consumers having little notice of the increased rate [often automatically triggered by unexplained declines in ones credit score]. In some cases, merely opening another account (i.e., dept store card) triggered the downgrade in credit score … One of the curious cases cited was a consumer that had four credit cards from the same company (the argument is that she should have similar rates based upon this type of model); her current interest rates: 8%, 14%, 19%, and 27%.

My opinion – legislative change often never occurs; I wonder how much of this “conversation” is in hopes that the credit card companies will change questionable practices on their own prior to changes in law. Not a bad start. Citigroup and Chase recently have said they will discontinue the practice (Citigroup has already stopped) and Chase will take effect in March. We’ll see if others follow suit.

What are legislators seeking? Ultimately, everything I’ve read really boils down to two requests:
(1) Clarity for Consumers. The Truth in Lending Act [specifically Regulation Z] is designed to promote consumer awareness of loan terms. The argument on the part of consumer advocates is that credit card billing and interest rate practices are much too complex for an “average” person to understand. The proposed rule change would require card issuers to ultimately redesign card applications and solicitations [enhancing disclosures] providing clearer [more easily understandable] information on fees.

(2) Mandatory Notification. The second item currently being requested would require card companies to give its customers at least 45 days notice before ‘penalty pricing’ (raising rates).

Additional Resources.
- AP Article: Credit Card Execs Defend Rate Policies

- Truth in Lending Act