Interest rates continue> to tumble for the U.S. Treasury, companies and home buyers alike. But for a large portion of 381 million U.S. credit-card accounts, borrowing rates have been moving only one way: up.
And average rates are likely to climb further in the near future.
New credit-card rules that took effect Sunday limit banks' ability to charge penalty fees. They come on top of rule changes earlier this year restricting issuers' ability to adjust rates on the fly. Issuers responded by pushing card rates to their highest level in nine years.
In the second quarter, the average interest rate on existing cards reached 14.7%, up from 13.1% a year earlier, according to research firm Synovate, a unit of Aegis Group PLC. That was the highest level since 2001.
Those figures look especially stark when measuring the gap between the prime rate the benchmark against which card rates are set and average credit-card rates. The current difference of 11.45 percentage points is the largest in at least 22 years, Synovate estimates.
By comparison, the spread between 10-year Treasurys and a standard 30-year fixed-rate mortgage is just 1.93 percentage points, near historical averages, according to mortgage-data provider HSH Associates.
The moves are driven by a combination of forces. The Credit Card Accountability Responsibility and Disclosure Act of 2009 has given card issuers less flexibility to raise interest rates as they wish. At the same time, issuers are still dealing with credit-card delinquencies that remain above historical levels.
"The rules have changed and the goalposts of risk have changed," says Paul Galant, chief executive of Citigroup Inc.'s Citi Cards unit.
Banks used to boost rates in a hurry on borrowers who fell behind on payments or otherwise turned out to be surprisingly risky. However, under the Card Act, financial institutions must warn customers at least 45 days before making substantial changes to rates or fees. People can avoid future rate increases and pay off existing balances over time.
As a result, most changes affect only new credit-card purchases. New rules that took effect Sunday limit what banks can collect in penalty fees, too.
Now bank executives say they need to be smarter when setting the initial interest rates on credit cards. In many cases, that means starting off with a higher rate. "We can't come up with penalty pricing or if we can, quite frankly, it's too late to do much good," says Stephanie Keire, head of consumer credit-card risk management at Wells Fargo & Co.
The sponsor of the Card Act, Rep. Carolyn Maloney (D-NY), said that despite the rising rates, the law benefits consumers because it eliminates unwelcome surprises and provides them with a clear picture of the costs they will face. "Better that consumers should know up-front what the interest rate is, even if it's higher, than to be soaked on the back-end by tricks and hidden fees."
At Discover Financial Services, a diminished ability to boost rates is causing the Riverwoods, Ill., company to offer fewer interest-free balance transfers for new customers, says Discover President Roger Hochschild. Balance transfers have declined 60% from last year. A typical offer might include 0% interest on the transferred amount for a year, with customers paying a balance transfer fee.
More increases are looming as card issuers respond to the new penalty-fee limits, says Ken Paterson, vice president of research at Mercator Advisory Group.
Many banks rushed to boost rates before limits on increases for existing customers took hold in February. Some lenders have recently raised rates for new borrowers. For example, Capital One Financial Corp. in June increased the rate on its Classic Platinum for Young Adults card by 2.9 percentage points from the previous 16.9%, and increased the rate on its No-Hassle Cash Rewards card by 1.9 percentage points.
In May, Wells Fargo & Co. increased the interest rate on new Cash Back Home Rebate, Platinum and College cards by one percentage point. Citigroup boosted the minimum rate on its Platinum elect card by two percentage points in July. The higher rates apply to new accounts.
Besides raising, rates, increasingly stingy lenders are revamping some of their underwriting techniques. Banks are relying more heavily on what is known as trend analysis to determine which borrowers are showing signs of improvement or weakness in their financial condition, says Steven Wagner, president of Experian PLC's Consumer Information Services unit.
A credit-card applicant might be considered too risky if he used much of his existing credit in recent months. That could increase the chances that the borrower might be denied a new card or charged a higher rate.
Some issuers want to better use their data on existing customers. Bank of America Corp. says its move in March to merge its deposit-gathering and credit-card units was aimed partly at weighing existing relationships with the Charlotte, N.C., company more heavily in credit decisions.
Bank of America now is more likely to offer customers with large deposits at the bank a lower rate, higher credit limit or better rewards than similar borrowers it knows less about.
Meanwhile, lenders are quicker to reduce credit lines at the first signs of financial stress, including late payments on other bills, a pay cut and unemployment. Several large U.S. banks have begun parsing employment and income data for changes that could affect the riskiness of existing customers, says John Cullerton, vice president at Equifax Inc. He declined to name the lenders.
In an effort to better manage risk, card issuers are handing out less credit, too. The credit limit on new bank cards averaged $3,923 in May, the latest month for which data are available, according to Equifax. That is down 11% from an average of $4,422 a year earlier.
Rising interest rates on many credit cards won't necessarily lead to more profits for issuers. "The interest-rate increases are designed to improve and protect profitability," says John Grund, a partner with First Annapolis Consulting Inc., but stubbornly high delinquencies and Card Act curbs will eat into those gains, at least in the short term.
Most cards now carry variable rates, meaning any increase in the prime rate is likely to be quickly passed along to borrowers. "Consumers will end up getting squeezed" when the Federal Reserve begins to raise rates as the economy recovers, says Ben Woolsey, director of marketing and consumer research at CreditCards.com.
Still, some bank executives say the interest-rate trend is likely to reverse as the U.S. economy recovers. "This is a very competitive industry," says Kenneth Clayton, senior vice president at the American Bankers Association, a trade group. "Somebody will take advantage of lower defaults to drive prices down."