Thursday, October 22, 2009

Banks’ Actions on Credit Cards Undermine Consumer Protections

Low- and middle-income households with credit card debt owe, on average, $9,827 on their cards. If you make the minimum monthly payment -- under many agreements 2 percent of the balance or $10 -- at 10 percent interest, it will take you more than 26 years to pay off the balance, including $6,812 in interest payments.

But what if the rate was raised even higher, or if your rate was tacked to the prime rate (currently 3.25 percent). It could take more than a lifetime to pay off that kind of debt.

In May, Congress adopted the Credit CARD Act to protect consumers from capricious rate hikes. Under the act, banks must give consumers at least 45 days notice before raising their rates. And beginning in February 2010, banks cannot raise rates on existing balances unless a consumer is in default.

Just last week, however, House Financial Services Committee chair Barney Frank accused banks of abusing the “grace period” they were given before all the law’s provisions take effect. Unfortunately for consumers, he’s right.

For example, Wells Fargo announced last week it was raising rates on existing accounts by up to 3 percentage points. Other card issuers, including such large banks as Bank of America and JPMorgan Chase, also have been accused of raising rates on balances prior to the law’s effective date.

Additionally, in June, Bank of America and Chase switched many cardholders from fixed- to variable-rate cards. Variable-rate cardholders are not protected from unexpected rate changes under the new law, because rate changes are permitted as the prime rate moves up and down.

Those most likely to be harmed by higher borrowing costs are consumers who are relying on their credit cards to carry them through the economic downturn. According to Démos, a non-partisan research and advocacy organization, most low- and middle-income households with high debt-stress levels -- the ratio of a family’s credit card debt to their annual income -- use their credit cards to pay for unavoidable expenses, such as medical expenses or to cover household essentials after a job loss, not for discretionary items.

Higher rates lead to longer payoff periods and thousands of extra dollars in interest payments. Let’s take the case of the average low- and middle-income households with $9,827 in credit card debt. If they continue to make the minimum monthly payment on that amount but at 13 percent interest plus prime, rather than our previous example of 10 percent interest, it must pay $19,897 in interest payments over the more than 45 years it will take to clear the balance. And because the prime rate is at historically low levels, this example likely presents a best-case scenario.

Many cardholders have responded to the downturn and the higher borrowing costs by reducing their debt. In July, revolving credit, which is largely credit-card borrowing, declined. For many, however, reducing debt during these tough times is not an option.

Moreover, changes in the availability of credit are also making it more difficult for cardholders to protect themselves from the banks’ actions. In the past, cardholders could demand better terms by threatening to take their business elsewhere. Today, this option is limited, because many banks have tightened credit-card approval standards.

Banks may be putting themselves at risk by their actions as well. If consumers are subjected to usurious rates as the prime rate rises, more will inevitably default on their debt. Banks will find it difficult to make up for these losses by further raising rates on consumers who are already stretched to their limits.

Bank of America vowed last week to stop raising interest rates before the February limits take effect, making the announcement as Rep. Franks’ committee met to consider moving up the effectiveness date of the new legislation. But such a promise offers too little, too late for many consumers who have already been harmed.

It is time for banks to rethink their recent moves and for Congress to do more to protect consumers.

By Jamie Lau

Jamie Lau is a research fellow with the Community Enterprise Clinic at Duke Law School.

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