New Rules Likely Making Credit Cards More Expensive

New rules designed to limit credit-card issuers from quietly raising interest rates and fees will undoubtedly help consumers become more aware of the terms and conditions on their credit cards. But the real news is that the Credit Card Accountability, Responsibility and Disclosure Act of 2009 (CARD) may actually be making credit cards more expensive to use.

The CARD Act placed strict limitations on how and when the credit-card companies can raise interest rates and fees, but the credit-card companies are pushing back — with higher rates and fees. All this is a good reminder that although credit cards are a convenient way to help manage your spending, it may be more important than ever to use them with caution.

Meet the New Rules

Under the CARD Act, which took effect in February, credit-card issuers:

• Must give a 45-day advance notice of an increase in interest rates, fees, or other significant charges.
• May not increase the interest rate for the first 12 months after an account is opened unless the card was offered with an introductory rate, which must last for at least six months.
• May raise rates on existing balances only when a payment is 60 days or more past due, when a promotional rate expires, when the consumer either completes or fails to complete a workout plan, or when a variable rate increases because of movement in the underlying index. If a rate hike is the result of a late payment, the lower rate must be reinstated after the consumer makes six months of on-time payments.
• May not charge an over-limit fee without first obtaining the cardholder’s consent and disclosing the amount that will be charged for exceeding the credit limit.

Watch for Higher Rates and Fees

As you might expect, these new rules pose obstacles to profitability for credit-card issuers. Because they have known for some time that the restrictions were coming, many companies have already raised their interest rates and existing fees or have put new fees in place.

For example, one year before the CARD rules took effect, the average annual percentage rate on credit cards was 11.8%. Since then, the average APR has been climbing steadily, reaching 13.5% in the fourth quarter of 2009 and 14.2% the week before CARD took effect, the highest rate in five years. Subprime borrowers have seen an even steeper increase: the APR rose from 14.3% in the third quarter of 2009 to 25% the week before CARD took effect.¹

The outlook for variable-rate cards is also daunting. The spread between the prime rate and the average APR is more than 10%, the widest in a decade. In 2007, the spread was a mere 4.8%.²

The prime rate is the federal funds rate plus 3%. Although the Federal Reserve is not expected to raise the fed funds rate soon, an increase is bound to occur eventually. When it does, interest rates in all variable-rate cards tied to the prime rate will also rise. Experts are expecting an average APR in the high teens by the end of 2010, possibly surpassing 20% in 2011.³

Annual credit-card fees, once on the verge of extinction, are also making a comeback. Roughly 35% of cards now carry an annual fee, the highest level of the decade.⁴ Others are expected to join in, and several are imposing new fees for balance transfers and account inactivity. Also, keep an eye out for rising late charges, plus new fees for cash advances, paper statements, and foreign transactions.

How Will You React?

We’ve all known smokers who were inspired to stop when legislators piled on new tobacco taxes. In the same way, the CARD Act may motivate people who are dependent on their credit cards to finally kick the habit. However, most of us will still need to use credit cards. Just try renting a car or booking a commercial flight without one.

It’s more important now than ever to keep a close eye on your statements. If your card issuer informs you of a pending rate increase, you’ll have plenty of time to pay down your balance or close out the account. If your issuer decides to levy an annual fee, you may want to consider switching to a new card. Research shows that three out of four card users will either cancel or consolidate cards that impose an annual fee, and there’s bound to be a company that sees an opportunity to pick up these new customers with a fee-free card.⁵

Perhaps more important is the need to reevaluate the role that credit cards play in your overall financial picture. Credit cards will probably always remain an important tool for consumers, but as they become more expensive, some users may want to consider other options for financing larger purchases.

1–5) The Wall Street Journal, February 21, 2010

The information in this article is not intended as tax or legal advice, and it may not be relied on for the purpose of avoiding any federal tax penalties. You are encouraged to seek tax or legal advice from an independent professional advisor. The content is derived from sources believed to be accurate. Neither the information presented nor any opinion expressed constitutes a solicitation for the purchase or sale of any security. This material was written and prepared by Emerald. © 2010 Emerald.