The Federal Reserve yesterday approved final rules aimed at protecting consumers by prohibiting certain unfair acts or practices by credit card issuers. The new rules were adopted under the Federal Trade Commission Act, and similar rules were concurrently adopted by the Office of Thrift Supervision and the National Credit Union Administration. The good news for consumers is that the new rules are comprehensive and address some significant abuse by some credit card issuers. The not so good news is that the rules do not take effect until July 1, 2010.
The rules cover both credit card practices and disclosures. Here is a rundown of the new regulations related to credit card practices and the impact they may have on your credit cards.
Fed Rules Prohibiting Certain Credit Card Practices
The Federal reserve adopted regulations prohibiting several common credit card practices:
- Time to Make Payments: The final rule prohibits banks from treating a payment as late unless the bank provides a reasonable amount of time for the consumer to make that payment. The rule provides what is called a “safe harbor” for banks that send credit card statements at least 21 days before the payment due date. This means that banks will be deemed to have complied with this regulation if they send out statements at least 21 days before they are due. It does not mean, however, that a bank has necessarily violated this rule if it gives consumers less than 21 days. Nevertheless, most banks are likely to take advantage of the safe harbor provision.
- Allocation of Payments: When different annual percentage rates (APRs) apply to different balances on a credit card account (e.g., purchases, balance transfers, cash advances), the final rule requires banks to allocate payments exceeding the minimum payment to the balance with the highest rate first or pro rata among all of the balances.For example, assume that a consumer had a $10,000 balance on a credit card, $5,000 from a balance transfer offer at 0%, and $5,000 from purchases at 12.99%. Today, most credit card companies would allocate 100% of payments exceeding the minimum required payment to the 0% balance transfer, resulting in the highest possible interest rate charge to the consumer.Under the new rule, any payments exceeding the minimum payment would have to be allocated either entirely to the high interest balance first, or allocated in equal parts to both the high interest and low interest balances. Until your credit cards comply with this rule, it is important to keep balance transfer credit cards separate from the cards you use day to day.
- Increasing Interest Rates: The rules require banks to disclose when the credit card is first obtained all interest rates that will apply to the account. The rule further prohibits increases in those rates, except in certain circumstances:
- If a rate disclosed at account opening expires after a specified period of time, banks may apply an increased rate that was also disclosed at account opening. This would apply, for example, with 0% introductory rates on balance transfers or purchases.
- Banks may increase a rate due to the operation of an index where the rate charged is variable. Note that while there are fixed rate credit cards, most use variable rates.
- After the first year, banks may increase a rate for new transactions, but only after giving you 45-day advance notice.
- Banks may increase a rate if the minimum payment is received more than 30 days after the due date.
- Two-Cycle Billing: The rules prohibit credit card issuers from calculating interest using a method referred to as two-cycle billing. Under this method, when a consumer pays the entire account balance one month, but does not do so the following month, the bank calculates interest for the second month using the account balance for days in the previous billing cycle as well as the current cycle. In other words, two-cycle billing can result in you paying interest on money you already paid back to the credit card company. It is a confusing, unfair and ridiculous way to calculate interest.
- Financing of Security Deposits and Fees: This part of the rule is aimed at “bad credit” credit cards, or subprime credit cards. Banks would be prohibited from financing security deposits and fees for credit availability (such as account-opening fees or membership fees) if charges assessed during the first 12 months would exceed 50 percent of the initial credit limit. The rule also limits the security deposits and fees charged at account opening to 25 percent of the initial credit limit and requires any additional amounts (up to 50 percent) to be spread evenly over at least the next five billing cycles.These credit cards are worse than payday loans. In some instances, a consumer is given a card with say $300 in credit, but then charged fees that take up 75% of the available credit or more. The Fed is putting an end to that practice.
On balance, these regulations seem quite sensible. But we should recognize that there will be some potentially negative consequences for consumers because of these regulations, too. For example, they will likely prevent some consumers from obtaining credit, and they may very well increase the cost of credit for others. One of the Fed’s Board members recognized this impact in a statement released yesterday:
As in most rulemakings, it is important that we try to strike the appropriate balance between competing points of view to achieve our objectives while minimizing the risk of unintended consequences. Unfair practices can impose significant costs on consumers. Likewise, the new rules will have a cost, too. In addition to extensive changes in disclosures, financial institutions will be required to make changes to their business models and alter certain practices. Although consumers might see some costs decline as new business models emerge, consumers might see other costs increase. Creditors may need to strengthen upfront underwriting efforts in the process. Over the long term, however, we expect the costs of making the required changes will be outweighed by the benefit of creating significantly clearer credit card pricing. In sum, our intent is to increase transparency and fairness in how credit card and deposit accounts operate, thereby enhancing competition and empowering consumers to better manage their accounts and avoid unnecessary costs.
Currently pending in Congress are two credit card reform statutes that could add further consumer protections if enacted.