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Credit card penalty rates: Mistakes that trigger default APRs

One late payment and default rates could kick in

By Amy Buttell Crane

Compared to credit card companies, the criminal justice system is downright lax. A court may throw away the key after you've committed three felonies -- the famous "three strikes and you're out" laws. Not so with credit cards. With many issuers, pay late, bounce a check or go over your limit once, and you're sentenced immediately -- with penalty rates.

How to avoid credit card penalty feesWhile not all credit card companies impose penalty rates -- also called default rates -- for making just one late payment, bouncing one check or going over your credit limit once, many do after a combination of two or three late payments, bounced checks or exceeded credit limits in a year.

Under such conditions, your interest rate could increase to as high as 31.99 percent, with the average penalty or default rate being 26.87 percent, according to a July 2008 study by the consumer rights group Consumer Action. The Consumer Action study examined rates and policies at credit card issuers and gathered data on 38 credit card issuers that have penalty rate policies.

"For customers of card issuers where an increase in rate is triggered by one late payment, it might not be so harsh if they gave you a reasonable amount of time to pay," says Linda Sherry, a spokeswoman for Consumer Action. "But many will impose those rates if you are one day late paying. What really bothers me about this whole issue is that most card issuers will not tell you how you can get back to a lower rate."

Once penalty rates take hold, they can rapidly increase your card balances, says Christine Moriarty, a financial planner in Bristol, Vt. "With rates of 20, 25 or 30 percent, a balance of even a few thousand dollars can grow quickly, causing you to fall further behind as your minimum payments escalate."

If you have already been sent to the penalty rate box, there are some steps you can take to get out. And if you haven't made late payments, bounced a check payment or gone over your limit, you'll want to do everything you can to avoid making these mistakes in the future, notes Sherry, as these issues are major penalty rate triggers.

What are penalty rates?
Penalty rates -- often called default rates -- are exactly what the name implies. They are higher rates imposed by a credit card issuer to penalize you for paying late, exceeding your card limit or bouncing a check that you sent to make a payment. As Moriarty notes, once you trigger a higher interest rate for any reason, your payments swell. For example, say you have a $5,000 balance on a credit card, and your interest rate is bumped up to the Consumer Action-average penalty rate of 26.87 percent. If you made a minimum payment of 4 percent ($200 a month), you would pay $2,397 in interest over 37 months before your balance would be paid off.

3 common ways to trigger penalty rates
Here are the three most-common ways to trigger penalty rates:

1. Late payments -- It doesn't matter whether you are one day, one week or one month late in making your payment: to most credit card companies, late is late. Most issuers set up their computer system to assess penalty rates the day after a missed payment. Some issuers will permit two late payments before applying default rates, but that is usually the limit at which higher rates will apply. Your issuer's exact definition of "late" is contained in the fine print of your credit card agreement.

Consumer Action's survey shows that the average grace period for the 41 issuers surveyed is 23 days. The shortest was 20 days, and the longest, 31 days. The grace period is the number of days after the close of your credit card billing cycle that you have to pay your bill without incurring interest charges. So, if your billing cycle ended on Sept. 30,  and your grace period is 25 days, you have to pay off your balance by Oct. 25 to avoid being charged interest. If your payment is processed on Oct. 26, you're late, possibly triggering penalty rates and fees.

Also, if you pay too early -- before the end of the prior billing cycle -- your payment will count toward your previous bill and not the new bill. If you don't send another payment during the current billing cycle, you could be charged penalty rates and fees. "If you are paying a chunk of money on your card and pay before the new grace period, you could be charged penalty rates even though you made a large payment, just because you made it too early," says Sherry.

2. Exceeding credit limit -- Once, credit card issuers would bounce charges when you went over your limit. Now, instead of bouncing charges, they hit you with over limit fees and penalty rates. You exceed your credit limit when your balance is larger than the limit that your credit card issuer has granted you. So, if your limit is $5,000, and you charge something that puts it to $5,050, you are over the limit.

Interest can also take your card over the limit as it mounts on balances you carry on your card. Some card issuers surveyed by Consumer Action don't impose penalty rates until you exceed your limit two or three times, while others impose them if you go over your limit once.

Consumer Action also found that some credit card issuers will cut a customer's credit limit below the current balance, forcing you to make a large payment to get back under your limit and incur over limit fees. These credit limit cuts may also trigger penalty rates on your remaining balances, a practice that Sherry labels as "unsavory."

3. Bouncing checks -- Nearly half of credit card companies impose penalty rates if a payment bounces due to a lack of funds in your checking account, according to Consumer Action's survey. Most credit card issuers and your bank would likely also charge bounced check fees, which could easily add up to $80 per bounced check.

Climbing out of the default rate pit
If you are already paying default rates, your ability to get out of it depends on your issuer and how many times you've made late payments, bounced payments or gone over your limit. "The first thing to do is to pick up the phone and call your card issuer," says Sherry. "The one time I paid late, I got hit with fees and higher rates, so as soon as I realized what had happened, I called my credit card company and reminded them that I had been a loyal customer for five years, and this was the first time I had paid late. They did put the rate back down."

It might not be so harsh if they gave you a reasonable amount of time to pay. But many will impose those rates if you are one day late paying.

-- Linda Sherry, spokeswoman
Consumer Action    

The worst thing you can do is ignore the situation, says Moriarty. "Many people are so overwhelmed that they don't even look at their credit card bills anymore," she says. While you are busy stuffing unopened credit card bills in a drawer, interest and penalties are climbing higher.

Should your credit card company be unwilling to lower your rate to its previous level, ask what steps you can take to get the rate back. Usually, a certain number of on-time payments will do the trick. If you can't get a straight answer out of the customer service representative, ask to talk to the manager. Keep pushing until you get an answer to your question.

Another option, if your credit is still good, is to find a low interest rate card that you can transfer your balances  to without charge. This will get your interest rate down so that you can pay your debt off faster.

With the current economic turndown, many consumers are struggling to make minimum payments on their cards as their overall debt load spirals out of control. If this is you, consider visiting a credit counselor certified by the National Foundation for Credit Counseling or the Association of Independent Credit Card Counseling Agencies. A qualified credit counselor can help you figure out the extent of your debt problem, work up a repayment plan and negotiate with your creditors.

See related: 6 tips to avoid penalty rates

Published: September 25, 2008


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