Will the credit card reform law hurt more consumers than it helps? Ask a credit card issuer and the answer is sure to be a resounding, “Yes!” A consumer advocate would reply, “It’s a bluff,” or “Any pain is worth the gain.”
In the months leading up to passage of the Credit CARD Act of 2009, banking industry lobbyists warned of the dire consequences of restricting card issuers’ abilities to increase interest rates based on the creditworthiness of borrowers.
Among the potential consequences cited by bankers:
- Rate hikes for everyone. Higher interest rates for all card users — even people who pay their bills on time and have good credit.
- Dumping riskier customers. Reduced credit limits or no credit at all for people with bad credit.
- You gotta pay to play. The return of routine annual fees for all account holders.
- Fixed no more. Variable instead of fixed interest rates on all accounts.
- No-interest balance transfers. Low teaser rates and zero percent balance transfer offers may go to select customers.
- Rewards less rewarding. Cash-back incentives, exotic rewards and airline miles would be scaled back.
- The vanishing grace period. Rather than waiting a month to begin charging interest on purchases, interest will start accruing right away — eliminating the so-called grace period. Even if you paid your bill in full each month, you would still be charged interest for the period between the purchase date and the end of the billing cycle.
- The unknown. New fees for services not specifically banned in the law.
That’s the potential downside to a slew of new consumer protections included in the new legislation, namely limiting when interest rates can be increased, requiring the fees are reasonable and giving cardholders more time to pay their monthly bills. The law will be phased in over 15 months, with major restrictions taking effect in February 2010. The earliest provisions — giving consumers the right to — kicked in Aug. 20, 2009. The legislation largely mirrors federal rules finalized in December 2008 and scheduled to take effect starting July 1, 2010. (See “Credit card reform law time line.”)
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How likely is it that card issuers will actually follow through on raising interest rates and slashing their account rolls? Many of the banks have already started jacking up rates and cutting credit limits because of the economy and in anticipation of the upcoming credit card law. Depending on who you ask, predictions of credit constriction by the banking industry were bluffs and posturing to build opposition to reforms, or real business strategy to regain profit margins squeezed by regulation.
The law and regulations will usher in a fundamental shift in how credit card issuers conduct business, says Peter Garuccio, spokesman for the American Bankers Association. “Card issuers will have to look at their entire pricing models and portfolios. They have to look at how they can operate and function in the new environment. The impact on consumers could be significant.”
He adds: “The unintended consequences are increased interest rates and reduced access to credit cards for consumers. Both of those things are highly likely.”
“I do think a lot of the talk was bluff,” says Linda Sherry, national priorities director for Consumer Action, a San Francisco-based consumer advocacy group. “We may see a few changes in how card companies derive income, but they would be fools to try to replace the huge profits they have gathered from penalty fees and interest rates with new tricks and traps in this new era.”
From a business standpoint, increasing interest rates and alienating customers you may need for future growth may not be a smart move, according to industry analysts. Competition between banks for the best customers may keep them from dramatically increasing rates. Although the top 10 credit card issuers control 80 percent to 90 percent of the market, they are still highly competitive, says Garuccio from the banking trade group.
“If one issuer decides that implementing a new program gives them an advantage, that is the route they will take,” Garuccio says, adding. “We’ll have to see how it will play out.”
Credit card issuers say they are preparing for the new law with risk reduction in mind. JP Morgan Chase told investors in February 2009 it was preparing to move all accounts to variable rates, charge higher interest rates when new accounts open and tack on annual fees for those customers with low usage on their cards. Credit card isuers make money from interest and fees charged to cardholders and from interchange fees charged to stores and merchants during every transaction. People who rarely use the credit card are not generating income for the issuer.
American Express CEO Kenneth Chenault told investors during a May 20 conference call that AmEx is focusing more attention on charge accounts — which must be repaid in full each month — rather than revolving credit accounts and that the company will “hurt less than our competitors” under the new credit card law. He said the impact to AmEx will be “massive.”
“We’re still studying what the impacts will be,” Chenault said. “We’ve anticipated some of it, and at the end of the day what we believe is that we’ll be able to manage through it.”
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Bank of America spokeswoman Betty Riess said it’s too early to speculate about specific changes the company might make.”It’s our intention to continue providing credit to the broadest number of creditworthy customers possible, while remaining prudent in our lending practices,” Riess said in an e-mail.
Difficult choices ahead
Will Black, an analyst for Moody’s Investors Service, a New York credit rating agency, says card issuers have a difficult choice ahead.
“There’s a negative consequence to repricing. Some portion of your borrowers will not be able to afford the new pricing. There’s a possibility they could charge off, could go into delinquency,” Black says. “In times past, that negative consequences was immaterial.”
He adds: “Increasing prices in this kind of economic environment is a trickier proposition than it has been in the past.”
Payment industry consultant Bruce Cundiff says building relationships with customers over the long haul should be a key goal for card issuers.
“The card issuers that are going to survive are going to look beyond increasing fees,” says Cundiff, director of payments, research and consulting for Javelin Strategy and Research, a Pleasanton, Calif., financial services consulting firm.
Sherry, from Consumer Action, says consumers should comparison shop and find the best terms for their needs.
“If they do implement, for instance, some annual fees, cardholders really have to do the math to make sure it makes sense to pay an annual fee. For instance, it might make sense if you can get a low APR in return for a $20 or $25 annual fee, if you need to carry a balance. Or maybe $20 per year is a cheap alternative to a charge card, which must be paid off every month and usually come with high fees.”
Before the economic downturn, default rates on credit card debt hovered at about 5 percent — meaning 95 percent of cardholders had no problems paying their bills on time. The rate has crept upward and Moody’s projects it will peak at about 12 percent by the second quarter of 2010.
Another reason why the banks might not be bluffing about what’s ahead: Funds generated by selling future credit card payments to investors — called securitized credit card debt — may be better off with tighter restrictions on who can get credit.
“When things have normalized, if the response by issuers has been to be more selective about who they lend to, if they give them less in credit lines and charge more for the loans, all those aspects have a positive impact on the portfolios,” Moody’s Black says.
Cundiff and Garuccio point out that the majority of Americans manage their credit well and pay their bills on time. Millions enjoy the benefits of rewards programs that offer vacations, hotel stays and other perks for using their cards. Cundiff says the people who are struggling to pay their bills and who are in need of the relief provided by the new credit card reforms are “a small subsection of the overall consumer sector.”
Adds Sherry: “The cardholders who have gotten good at making money (or at least not paying any) off of credit cards may find that they are asked to pay their way.”
See related:Credit card reform and you, Obama signs credit card reform bill into law Interactive timeline: How the credit card reform bill became law and when its provisions take effect, Annual fees return in credit card mail offers, House easily passes credit card reform bill, Senate passes tough new credit card bill, How to cope until the new credit card rules take effect, What the new credit card rules mean for you, Feds: Close interest rate loophole in new credit card ruels, New credit card rules don’t cover business, corporate credit cards, House OKs Credit Cardholders’ Bill of Rights, House committee OKs Cardholders’ Bill of Rights, Credit Cardholders’ Bill of Rights passes first legislative hurdle, Federal banking regulators finalize sweeping rule changes for credit cards, House again weighs Cardholders’ Bill of Rights