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Fed knocks the 'floor' from under variable credit card rates

Card interest rates must be allowed to fall, not just rise, issuers told

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The Federal Reserve has knocked the "floor" out from under variable interest rate credit card accounts.

New Fed rules say variable card rates can go down, tooConsumer groups are applauding a new rule, released by the Fed this week, that will force credit card issuers to do away with a growing industry tactic that benefited banks but troubled consumer advocates: The Fed said that on variable rate credit cards, interest rates must be allowed to fall, not just rise.

It's good news for the increasing number of consumers who have variable interest rate credit card accounts that set "floors" on how low their rates could drop, but no ceiling on how high they could climb. The change was part of the 1,155-page final Fed rules released Jan. 12 detailing how banks should implement the Credit CARD Act of 2009.

Floor no more?
"For practical purposes, this more or less means that issuers cannot use these practices," according to Joshua Frank, a researcher from the Center for Responsible Lending and author of a December 2009 study about how credit card issuers were imposing new fees and dodging restrictions in the new credit card law.

"The Federal Reserve's rules on variable rates creates an environment that is safer and more fair for consumers," Frank said in an e-mailed response. "When issuers tell the consumer that they have a 'variable rate,' that rate will vary fairly and honestly with an index rather than being manipulated by the issuer. The rules on variable rate floors as well as other limitations on variable rate manipulation will save consumers well over a billion dollars."

The new credit card law restricts card issuers' previously unfettered right to jack up interest rates on existing card balances. But it has a limited number of exceptions. Among them: Card issuers may pass along rate changes if the account has a variable interest rate tied to an index that is not under the issuer's control.

The Fed's rules clarify that if a card issuer sets a floor on rates, it nullifies the exception.

"If it is a variable rate card with a floor, it doesn't qualify for the exception," confirmed Peter Garuccio, a spokesman for the American Bankers Association trade group. He said banks will likely have to revise how they operate variable-rate credit card accounts.

The vast majority of credit card accounts now have variable interest rates. That means their annual percentage rates (APRs) are based on the prime rate plus a margin. The prime rate as of Jan. 13, 2010, is 3.25 percent. So, for example, an account with a variable rate of prime plus 13.99 percent would have a 17.24 percent APR. 

While the rule is good news for consumers, it's not one that will benefit them any time soon. The Federal Reserve is keeping rates at historic lows to stimulate the economy and has indicated it will do so for an "extended period," so those variable rates won't actually vary any time soon. But when the Fed starts to raise rates again, it will mean a majority of consumers' credit cards will see their rates rise automatically. The new Fed rules mean that eventually, on the other side of the rate cycle when rates fall, those who hold variable rate cards without floors will enjoy the fall as well as suffer the rise.

'Troublesome' trend
Consumer groups noted another practice: Card issuers set the floors at high levels -- usually at the existing APR for a fixed rate account. "These floor rates create a situation where the interest rate is called 'variable,' but it can only vary upward relative to its starting value. The interest rates can never decline from where they start," according to Frank's report. 

We hope that this means in the future going down the road the Fed takes more seriously concerns that consumers have raised.

-- Kathleen Day    
Center for Responsible Lending    

In addition, the Pew Health Group's Safe Credit Cards Project released in October 2009 found use of the floors for purchase APRs had increased from 1 percent to 9 percent among the largest issuers of credit cards. Pew researchers called it a "troublesome emerging trend." 

"Our own analysis shows that while two of the top eight credit card issuers currently commonly use a floor equal to the current purchase APR, none of the top eight issuers used this practice on most of their cards five years ago," Frank notes in his report.

Ceilings OK
The Fed rules on variable rates includes another pro-consumer clause: Credit card agreements are permitted to have variable rate "ceilings" -- meaning the amount that APRs cannot exceed -- "because there is no disadvantage to consumers."

Kathleen Day, a spokeswoman for the Center for Responsible Lending, said they were pleased with the Fed's ruling on variable floors: "That they did it after concerns were raised by consumer groups, that's good. We hope that this means in the future going down the road the Fed takes more seriously concerns that consumers have raised."

See related: A guide to the Credit CARD Act of 2009, Credit CARD Act interest rate protections kick in

Published: January 15, 2010


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