Research and Statistics

Paid late? 6 on-time payments can erase penalty rate


Missed a couple of credit card bills and get socked with a penalty APR? New rules give you an opportunity to get your old rate back

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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, much higher annual percentage rate (APR) — otherwise known as a “penalty” rate.

Credit card issuers required to 'cure' penalty ratesNow, as a result of the federal credit card reform law, which became effective Feb. 22, 2010, you have the opportunity to undo 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).

Credit CARD Act ‘cures’
for reviewing high APRs
The new CARD Act provides for a couple “cures,” or tactics that may modify an interest rate hike. The rules that come into play when you’ve missed a payment by 60 days and then make six on-time payments differ slightly from those that apply when the rate jump wasn’t a result of a late payment, but rather at the whim of your credit card company.

In these cases, the card issuers are required to review these rate increases at least once every six months and assess whether the factors they used to warrant a rate hike, such as market conditions, have changed. In addition, they are required to reduce the rate if indicated by the review. However, no specific amount of rate reduction is required.

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.

“Although it’s a small improvement, it’s limiting,” because it applies only when account holders make six on-time payments right after a rate increase, says Lauren Bowne, a staff attorney with Consumers Union, the nonprofit publisher of Consumer Reports magazine. For cardholders who are having financial troubles — perhaps due to a job loss or medical emergency — it’s unlikely that they’d be able to immediately begin making payments on time, Bowne contends.

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, New Jersey, 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:

American ExpressWill review the account every six months following the effective date of the penalty interest rate. At the first review in which the customer has paid on time during the six preceding billing periods, American Express may remove the penalty rate within 45 days of the review, even if these payments did not start immediately following the rate increase. This would be decided on a case-by-case basis.
Bank of AmericaGenerally, will lower the interest rate after six consecutive months of on-time payments if the customer had been re-priced because of late payments.
BarclaycardDeclined to comment.
Capital OneDeclined to comment.
ChaseAn account that has incurred a penalty rate will be reviewed at the end of six complete billing cycles that reflect the new rate. If the customer has made six consecutive on-time payments, Chase will restore the pre-penalty rate. If the customer hasn’t made six consecutive on-time payments, the account will be included in future reviews, in which Chase may, but isn’t required to, lower the rate.
CitiDeclined to comment, other than to acknowledge that Citi is reviewing all the new guidelines but cannot disclose details about how it is implementing any one specific provision at this time.
DiscoverThis section of the regulations isn’t relevant to the company, since it eliminated default re-pricing on existing balances altogether, according to a Discover representative.
HSBCThe company did not comment, beyond saying that it has implemented the provisions of the CARD Act.
Wells FargoAs of July 6, 2010, Wells Fargo no longer places accounts into default or penalty pricing regardless of late payments. Accounts that went into default or penalty pricing before July 6 will remain at those rates until they cure; generally, that requires six on-time payments.
Source: research, October 2010.

See related: 2014 credit card penalty rate survey

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