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What to expect from credit card reform

President Obama has asked Congress to submit to him by Memorial Day a bill that will redefine the rules of the game when it comes to credit card lending practices.
/ Source: The Big Money

Ask not what your credit card legislation will do for you ... Actually, go ahead and ask; you might be pleasantly surprised. President Obama has asked Congress to submit to him by Memorial Day a bill that will redefine the rules of the game when it comes to credit card lending practices.

Currently, the Senate and the House are each working on their own versions of a credit card bill. In the Senate, an agreement reached earlier this week between Senate Banking Committee Chair Chris Dodd and Richard Shelby, the top Republican on that committee, virtually guaranteed Senate passage.

While the final details are still being ironed out, people who watch the consumer-lending industry have a pretty good idea of what it's going to include. The bill is expected to use as a springboard regulations passed back in December by the Federal Reserve Board, which would have gone into effect July 2010.

Below is an overview of what the final bill is expected to include and where you can expect some relief on your monthly statements:

Resurrect the grace period
Back in the day, you could drop your bill in the mail on the day it was due, give or take, and your lender would just cash your check when it came. Now, payments that aren't received—and logged in—by the end of the business day on the due date can trigger an avalanche of fees and penalties (some of which are described below). Especially galling to consumers is the stance taken by some card companies that even if it takes them a couple of days to process the payment, it's still counted as late. In order to avoid this, you could pay your bill well in advance of the due date, sparing you the fees but giving the company your money to play around with for those extra days.

The new law will give back some of that breathing room. Depending on which version Congress ultimately goes with, cardholder payments won't be marked as tardy unless they're either 30 or 60 days past the due date.

Scrap universal default
Right now, if you space out and forget to pay your Visa, MasterCard can turn around and spike your interest rate on the grounds that you suddenly look riskier to them. This practice is called universal default, and it means you could be stuck with interest rates of nearly 30 percent on literally all your credit cards because of a single missed or late payment.

Eliminate teaser rate spikes
The new rules will also prohibit credit card companies from promising you a low "teaser" interest rate and then spiking it after you've run out and bought a home theater or a leather sectional. They'll still be able to raise your rates, but they'll have to give you 45 days' notice and let you pay off your existing balance at the lower rate.

Cap penalty periods
Currently, if you blow off a payment, your interest rate shoots up-and stays there for as long as the credit card company wants. The legislation would cap the penalty period at six months; pay your bill on time for that duration and reclaim your regular, lower interest rate.

Regulate student borrowing
Stroll around any college campus and you're likely to be inundated with come-ons for easy credit in the form of signs, fliers, and, in nicer weather, sales reps hawking T-shirts or water bottles as sign-on inducements. The new bill doesn't explicitly prohibit many of these activities, but it would likely put the kibosh on the current free-for-all.

Those under 21 who want a credit card will have to either prove income or have a co-signer. Credit limits will be capped at either $500 or a percentage of their stated income, and any increases to the credit limit will have to be approved by the co-signer before taking effect.

Regulate overpayment allocation
If you make a payment above your minimum payment, the card company will have to apply that overage to the portion of the balance that's being charged the highest interest rate.

But wait — don't they do that anyway? Nope. In fact, credit card companies do just the opposite, almost always applying any overpayment to the portion of the balance accruing the lowest interest rate. In other words, you've got to pay off that $5,000 charged at the promotional 4 percent or 5 percent before they'll let you take a crack at the $500 that's racking up 13 percent interest each month.

Obviously, if someone's making extra payments toward his principal, he's trying to pay down that balance, but the Center for Responsible Lending says a whopping 97 percent of Americans don't understand that they have to pay off lower-rate balances before tackling the bigger fish.

That's a rundown of the good news, but consumer advocates still say the proposed legislation falls short in a number of ways. First, there's the question of timing. While both the Senate and House versions of the bill would kick in before the similar Fed regulations would take effect in mid-2010, the nine- or 12-month ramp-up period is still unacceptably long, watchdog groups charge. For its part, the credit card industry contends it's going to take it until 2010 to make the changes the Fed requires.

The legislation also can't do much about the pre-emptive steps the industry's been taking of late. According to the Center for Responsible Lending, the issuers controlling 80 percent of Americans' credit cards recently have been ratcheting up fees for everything from conducting balance transfers to accepting late payments, sneaking in one final scoop of rice pudding before the government closes the buffet.

A more under-the-radar tactic, as well as one that worries privacy advocates, is card companies' newly urgent quest to find out everything they can about you before lending you money. Card issuers have been aggregating data and using everything from customers' spending habits to psychological analysis to predict which ones will turn out to be deadbeats.

Pretty much the entire banking and lending industry objects to the anticipated legislation. It contends that the restrictions on fees and rate increases will take away credit card companies' ability to price for risk, leading to higher interest rates and less available credit for everyone. That's kind of a stretch. When the economy turned south, card issuers began weeding out their most default-prone customers by cutting their lines of credit or accelerating repayment, which they'd still be able to do.

Plus, although this was unthinkable during the boom years, they'll just start denying more people credit. The industry positions this as a bad thing. This is true to a point; some creditworthy borrowers could be left out in the cold. However, the current credit crisis—in which even responsible lenders are seeing their credit limits drop and rates go up—stemmed from the industry papering the country with applications (more than 6 billion in 2005 alone) and lending to anyone with a pulse. So if the new legislation means someone earning $16,000 a year can't get a $5,000 line of credit at his or her local housewares or electronics retailer, maybe that's actually a step forward.