April 8, 2008 at 8:00 AM ET
When the House Financial Services Committee meets again next week to discuss credit card reforms, they'll have something else to talk about -- a new way for credit card firms to raise your interest rate.
Discover announced recently that there's a new penalty for cardholders who exceed their credit limit, in addition to the $39 fee -- a higher interest rate.
Many consumers might not even realize that they can exceed their credit limit, and in fact the term has largely become meaningless. Card issuers give consumers what some call a "nominal limit," which is the credit limit printed on monthly bills. But nearly all allow consumers to exceed that limit by 10 percent or more (precisely how much is a secret), and then charge fees of $30 to $40 for each month the balance exceeds that limit.
In fact, credit limits might better be called "fee triggers." And now, you should think of them as interest rate hike triggers as well. More on that in a moment.
You might recall a minidrama that unfolded during a congressional hearing on credit card practices last month. The House Financial Services Committee had planned to hear from consumers complaining about credit card firm misbehavior at the March 13 meeting, but the witnesses suddenly refused to testify. The card companies, at the last minute, had demanded that each witness sign a waiver allowing the banks to discuss the consumers' personal lives in public, saying they needed the waivers in order to defend themselves. Given the timing of the demand, some saw it as an intimidation tactic by the banks.
Rep. Carolyn B. Maloney, D-N.Y., who called the hearings to debate her proposed Cardholder Bill of Rights legislation, hopes to hold the panel discussion next week, with a negotiated settlement of the consumers' privacy concerns in place.
"These good people deserve to have their voices heard on this issue, and I believe it is imperative that this committee hear real world examples of how this credit card bill would help consumers," Maloney said.
If the meeting occurs, Discover has provided additional fodder for discussion. The card issuer has made subtle changes to its member agreement that give it another excuse to raise consumer interest rates. Beginning May 1, any time a cardholder exceeds the nominal credit limit twice, the penalty interest rate will be imposed. That's a steep penalty, and getting steeper, too. Also on May 1, the penalty "default" rate jumps from 29 percent to 31 percent for Discover members.
"This is a significant increase," said Bill Hardekopf of LowCards.com, adding that using a credit limit transgression as an excuse to raise interest rates is new to the industry. "Consumers should know of the pitfalls that come with exceeding your credit limit. It's no longer just a charge that might hit you on a one-time basis. It might have far reaching effects on your interest rate."
Discover defended the practice as a necessary way to balance the cost of serving risky customers.
"(Higher rates) are imposed due to the increased level of risk that cardmembers represent when defaulting on their bills or exceeding their credit limits more than twice per year," said Discover spokeswoman Laura Gingiss. The higher rate and over-limit fee only apply if members do not pay their bill by the due date, she said.
Other card issuers appear to have similar provisions in their agreements. One Chase Platinum Visa offer indicates the cardholder's rate may increase if "you exceed your credit line." At Bank of America, a cash reward card contains the following provision: "Each time your ... account balance is over the credit limit, we may increase each of your account's Standard APRs up to the default rate. "
Getting hit with the default rate is a credit card user's equivalent of banishment – and it's a costly one. A consumer with a $10,000 balance and a 15 percent interest rate who pays the minimum payment each month would pay $2,800 in a year and still owe $8,598 on that balance. But a consumer paying 31 percent interest would have to cough up $4,047 to meet minimum balance payments during that same 12 months, and yet would fall farther behind, with a remaining balance of $8,891.54.
Remember, in that example, nothing has changed but the interest rate. (If you'd like to run your own nightmare scenarios, BankRate.com has a handy calculator).
That means knowing your credit limit is more important than ever.
"In this economy people are being stretched and stressed more and more, people are charging more items on their credit cards and running up greater credit card balances, and coming closer to their credit limit," Hardekopf said. "I'm sure a significant number of people don't know what their credit limit is on each credit card they have."
It's not clear when the practice of tying credit limit excesses to interest rate hikes began. It's also often not clear to consumers why their interest rate has been increased -- recently, many consumers reported receiving rate increases even though they were paying their bills on time.
Many consumers might be surprised to hear that even approaching their credit limit can have costly consequences. "Credit utilization" is a key component of credit scores, so spending up to credit limits can knock significant points off of credit scores. In fact, according to credit score expert John Ulzheimer, consumers looking for the best score should try to use only 10 percent of their credit limit. That means those with $15,000 cards should try to keep their balances below $1,500.
RED TAPE WRESTLING TIPS
KNOW YOUR LIMIT: It's easy -- and important -- to know your credit limit. It's listed on your bill. Card issuers sometime lower credit limits, so you should take a quick glance with every billing cycle
SIGN UP FOR WARNINGS: Some card issuers will send out e-mail warnings if your balance begins to approach your credit limit, says Hardekopf. Sign up for such warnings, which could save you a bundle in interest charges.
KNOW YOUR LIMIT ISN'T A LIMIT: Most important, shoppers should not rely on credit card issuers, or "transaction denied" messages at retailers, to avoid exceeding their limit. Card issuers will gleefully allow consumers to use more credit than they have, and charge handsomely for the privilege.