Credit Card Crackdown: 8 Key Issues

Updated on April 30, 2009. 

The momentum for tighter regulation of credit card issuers continues to grow, as the House of Representatives Thursday passed legislation that promises strong consumer protections.

Introduced by Rep. Carolyn Mahoney (D., NY), the Cardholders’ Bill of Rights aims to strengthen consumer protections offered by Federal Reserve rules and possibly speed up the date they go into effect (which, for now, is July 1, 2010). The bill recently cleared the House Financial Services Committee by a decisive 48 to 19 vote, passed Thursday by a bipartisan vote of 357-70.

Although the industry has long opposed tighter government oversight, chances are it will soon have to operate in a new reality. In a meeting with the heads of 14 major banks earlier this month, President Obama said he’d support legislation that bans unfair rate increases and fees, pushes for clear and transparent contract terms and card statements, and increases industry accountability.

Similar legislation is making its way through Senate. Introduced by Sen. Chris Dodd (D., Conn.), chairman of the Banking, Housing and Urban Affairs committee, the Credit Card Accountability, Responsibility and Disclosure (CARD) Act would offer even more consumer protections, including banning practices such as “any time, any reason” interest rate increases. (Separately from the legislation, Dodd has also called for an emergency freeze on credit card rates to be imposed by the Fed.) The bill has also received the administration’s seal of approval.

SmartMoney has been reporting card issuers' practices throughout the financial crisis. Here are eight of the most controversial issues for consumers.

The issue: As SmartMoney has reported, credit-card companies have been slashing borrowers’ credit limits in an effort to contain their rising default rates, in some cases to below the borrowers’ outstanding balances. The targets? Their best customers, says Dennis Moroney, research director and senior analyst for Tower Group, a research and advisory services firm focused exclusively on the financial-services industry. “They’re reducing lines on the [people with] better scores so that they can minimize the impact on the FICO score deterioration,” he says. (The higher one’s credit score, the more likely it is they are using a small portion of their available credit, which means their score will suffer less if the limit on one or more of their cards is lowered. Read more on this below.)

Impact on cardholders: Reducing one’s limit close to or below the outstanding balance may not only trigger an over-limit fee, it can also hurts the cardholder’s credit score. That’s because the credit utilization ratio, or the amount of credit used relative to the available limit, determines 30% of your credit score.

The fix: Under the new Fed rules, issuers have to give 45 days’ notice if the reduction brings the cardholder close to their outstanding balance, says Linda Sherry, spokeswoman for advocacy group Consumer Action. But these rules don’t take effect until July 1, 2010. Maloney’s bill would let consumers set “hard” credit limits that cannot be exceeded in the first place.

The issue: The Fed may have brought short-term interest rates close to 0%, but credit-card issuers have been lifting interest rates across the board. “At a time when banks are receiving federal aid and can borrow from the Federal Reserve at almost [no cost], it just does not make sense that interest rates should be that high,” says Nick Bourke, manager of the Safe Credit Cards Project at the Pew Charitable Trusts, a nonprofit group. A recent survey by the organization found that 93% of credit cards offered by the largest 12 issuers have contract terms that allow them to hike rates at any time, for any reason.

Impact on cardholders: Borrowers will take longer to pay off debts – and will pay more interest as they do so. To crunch the numbers yourself, use SmartMoney’s "How Much Interest Will You Pay?" worksheet.

The fix: The Fed rules prohibit banks from increasing rates in the first year after opening a credit card. Afterwards, a 45-day notice is required. Dodd’s Credit CARD Act would ban “any time, any reason” rate increases.

The issue: Even the most responsible credit card user could get hit with a 30% or higher penalty rate if they pay a day late or exceed their limit by $1. According to the Pew Charitable Trusts survey, 87% of cards allowed such automatic penalty increases, while the median penalty rate was 27.99%.

Impact on cardholders: Consumers end up paying high interest on past purchases.

The fix: The Fed prohibits such rate increases, except when a payment is more than 30 days late. Under Dodd’s CARD Act any rate increases would only apply to subsequent purchases.

The issue: Issuers apply consumer payments to low-rate balances while their high-rate balances keep growing.

Impact on cardholders: Anyone who takes advantage of a low-rate promotion, such as a 0% APR balance transfer, will pay more than 0% if they use the same card for purchases at a regular rate. “Any payment you send in will go to the 0% balance while your purchases keep running up high interest charges,” says Bourke.

The fix: Fed rules require payments exceeding the minimum to be allocated to highest-rate balance, or to all balances on a pro-rated basis. Dodd’s CARD Act would require allocation of the whole payment to the highest rate balance.

The issue: In an effort to limit their risk exposure, banks have been closing unused credit cards. Consumers who dust off such a card in hopes of keeping it may run into a surprise. “If someone is inactive for a long period of time and out of the blue the card comes out of the kitchen drawer and they start using it, chances are things have changed, and not in a good way,” says Tower Group's Moroney.

Impact on cardholders: Closing an unused credit card can lower your score, since it lowers your available credit and increases your credit utilization ratio.

The fix: So far, there is little to address this in the Fed rules and proposed bills.

The issue: Scaling down on rewards programs, some issuers have been quietly slipping in expiration dates for rewards points, cutting back promotional programs and asking cardholders to spend more points or miles for free flights. (For more details, read our story.)

Impact on consumers: It may do no monetary harm, but is unfair to consumers who may favor one card over another because of its rewards program, says Sherry.

The fix: The Fed doesn’t address rewards programs. Dodd’s CARD Act prohibits any changes to account terms until the card’s expiration date, which according to Sherry may include changes to the rewards program affiliated with the card.

The issue: Grace periods — the time between the statement closing date and the date by which cardholders must pay to avoid interest charges — have been shrinking, from an average 25 days in 1995 to 22.5 days in 2008, according to Consumer Action’s annual credit card survey.

Impact on cardholders: By the time they receive their statement, cardholders may have just days to mail a payment or risk being hit with late fees and penalty rates.

The fix: The Fed rules require that banks send statements at least 21 days before the payment due date. Legally, the end of a grace period doesn’t have to coincide with the payment due date, though it usually does, says Chi Chi Wu, staff attorney with the National Consumer Law Center.

The issue: On college campuses, card issuers are practically shoving credit cards in students’ pockets, making credit seem easy for those already taking on the burden of tuition and student loans.

Impact on cardholders: Debt levels have increased 44% among college seniors since 2004, who now owe an average $4,100 on credit cards, according to a recent survey by education loan provider Sallie Mae.

The fix: Dodd’s CARD Act prohibits companies from issuing cards to people under age of 21 unless they complete a certified financial literacy course. Maloney’s Bill of Rights prohibits issuers from knowingly issuing cards to individuals under 18 who are not emancipated minors.