Credit card issuers required to 'cure' penalty rates

Socked with a penalty APR? There's now a way to get your old rate back

By Karen Kroll

Most everyone has, at some time, paid a credit card bill late. Maybe you were traveling or the bill was misplaced or forgotten. If you've done it more than once, you may have had the shock of being socked with a new sky-high annual percentage rate (APR) -- otherwise known as a "penalty" rate.

Now, as a result of the new credit card rules, which became effective February 22, you have the opportunity to "cure" your penalty rate blues and return your account to its previous interest rate. 

Among the many new provisions of the Credit Card Accountability, Responsibility and Disclosure (CARD) Act of 2009 was one that requires card issuers to review the possibility of restoring these "penalty rates" to the original APR after a series of six consecutive on-time payments.  (This is one of a couple of provisions in the CARD Act that deal with interest rate increases. For more on another, see the box, "CARD Act cures," below.)

How does it work?
If a card issuer institutes a higher penalty APR (or  default rate) on an existing balance as a result of nonpayment over two billing cycles, the cardholder has to make six consecutive on-time payments before the rate will revert to the previous APR.

These payments must begin immediately after the rate jump. For example, say you miss two payments and notice a rate jump on your next bill. In order to get back to the interest rate in place before the rate hike, you'll need to make six on-time payments -- at the higher rate -- for the next six payment cycles. If you do that, the rate should automatically revert; you're not required to request the change.

A few caveats: This new rule applies only when the increased interest rate is applied to an existing balance because payment was 60 or more days late. This rule doesn't come into play on new purchases; according to the CARD Act, issuers can raise rates on new purchases with 45 days' notice. Case in point: If you make six on-time payments, satisfying the requirements of this cure, but still have some of your existing balance to pay off, your card issuer is required to charge the pre-penalty interest rate on this balance, but can charge another rate on any new purchases you make.

Another potential glitch in returning to your original pre-penalty rate exists when your card's APR is tied to the prime rate. Since the majority of credit cards today are variable rate cards -- meaning the APR can fluctuate with the prime rate -- if the prime rate changes during that six-month period of on-time payments, your "cure" rate would be different from  the pre-penalty rate. For example, if your pre-penalty APR was 13.25 percent, which is calculated by adding 10 percentage points to the prime rate, which is currently at 3.25 percent, and the prime rate rises to 5.5 percent once you've made six on-time payments, your new rate would be 15.5 percent (the prime rate plus 10 percentage points). 

On the other hand, the regulations don't restrict issuers from extending cardholders more of a break than what's required. For instance, they can return customers to their old rate if they make six on-time payments, but don't begin paying promptly until a couple of months after their rates were bumped up, as exemplified in American Express' policy (see chart below).

Who does it help?
The change in regulation is most likely to help cardholders who either overlooked a couple of bills or hit a temporary cash-flow snag. It will be less helpful to cardholders with shaky credit records, who are perpetually in debt and behind on numerous bills as their ability to make six on-time payments may be unlikely.

So, even with the new provision, these consumers likely will be paying the higher rate for an extended period, keeping them in a cycle of debt. Moreover, the regulations don't limit the penalty rates themselves, Bowne adds. "Penalty rates can be as high as the credit card companies want."

Conversely, cardholders who are hit with a penalty rate, but are able and willing to pay off their balances in fewer than six payments, won't see a break in their interest rate, either.

Michael Simkovic, an associate professor of law at Seton Hall University in South Orange, N.J., who has researched credit card regulation, says he believes the rule acknowledges the position stated by many credit card issuers: They need to boost rates when cardholders' payments are late in order to account for the higher risk of default or nonpayment. Many card companies have argued that if they are forced to charge everyone the same rate, they would only be able to extend credit to only the most creditworthy individuals.

This change in the regulation essentially accepts this thinking, while also acknowledging that cardholders who miss a payment, only to make six on-time payments, probably are not credit risks, Simkovic says. More likely, they simply overlooked the bill. When that's the case, the card companies "shouldn't get to play gotcha," by bumping up their interest rate forever, Simkovic adds.

When it comes to applying this regulation, here's how some of the largest card issuers say they're handling it:

See related: Survey finds credit card penalty rate can top 30 percent; how to avoid them, 6 tips to avoid penalty rates, Credit card penalty rates: Mistakes that trigger default APRs, Credit card penalty rate can top 30 percent; how to avoid them, A guide to the Credit CARD Act of 2009, Credit card penalty rate can top 30 percent; how to avoid them, Credit CARD Act interest rate protections already in effect, Credit card reform law quirk: 45 days' notice becomes 14

Published: October 8, 2010

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