Faced with mounting account delinquencies, major U.S. banks are penalizing credit-card customers late on payments by hiking their accounts to maximum default interest rates of 30% and more -- even those with good credit records.
Default rates imposed for late payments, exceeding credit limits and bounced payment checks typically are levied on cardholders with poor credit scores, often incrementally. But state banking regulators and watchdog groups report a growing number of complaints of maximum default rates being imposed on erring customers with above-average credit scores of 700 and higher.
The tighter rein on credit-card debtors comes amid heightened scrutiny in Congress of suspect industry practices. Lawmakers fear wary lenders will resort in the months ahead to "hair-trigger repricing" of interest rates on cardholder's existing balances at the least provocation. "We find it totally unfair that if you're one day late, you get hit with a 30%-plus interest rate," said Linda Sherry, director of national priorities for Consumer Action. "There's been a pervasive attitude of hands-off the industry because we don't want to tinker with the marketplace, but some of its practices are just patently wrong."
"Some issuers are pointing to the hits they've taken from the subprime mortgage fallout as a reason Congress shouldn't regulate the credit-card industry," said U.S. Rep. Carolyn Maloney, D-N.Y., chair of the House Subcommittee on Financial Institutions and Consumer Credit. But "the hands-off approach prior Congresses have taken to this industry has spawned unfair practices that hurt consumers, including hair-trigger repricing."
In a bid to forestall tighter regulation, leading card issuers Citibank and Chase declared this year they'd abandon highly criticized "universal default" policies. Under that practice, banks boost a cardholder's interest rate for delinquencies on outside accounts or a drop in their credit score even if they have a flawless payment record on that lender's account.
Consumer advocates said the banks made that concession knowing they'll need to take a harder line with customers as delinquencies rise and would face intense heat in Congress if they sharply hiked rates for so-called "off us" activity.
Citibank, which dropped universal default in March, declined to disclose whether it is since hiking late payers to maximum default rates more often or swiftly. "We reprice to our default rate only a very small portion of customers," spokesman Sam Wang said.
The decline in Americans' home equity due to slumping real-estate values is limiting cardholders' ability to pay off higher-interest credit-card debt with home-equity loans. As that resource becomes unavailable to more borrowers, experts say, lenders are taking aggressive measures to limit their exposure on unsecured credit-card debt.
Credit-card lending is the riskiest personal debt for banks to hold because, unlike mortgages or car loans, it's not secured by collateralized real property they can seize if borrowers fail to make payments.
Lenders are now confronting rising defaults on the $920 billion that the Federal Reserve estimates Americans currently carry in credit-card debt. Delinquencies of 90 days or more -- which lenders generally write off -- rose 18% to $961 million in October from a year earlier at 17 trusts holding 45% of U.S. credit-card debt, according to an Associated Press analysis of Securities and Exchange Commission filings.
Today's punitive default rates of 30% and more owe to the absence of usury ceilings in Delaware and South Dakota, which eliminated them during the 1981-82 recession to attract major banks' credit-card operations. Those states' subsequent big job gains came at the loss of interest-rate protections for cardholders nationwide.
States cannot impose their own rate ceilings because of a 1978 U.S. Supreme Court ruling that permitted banks to "export" uncapped credit-card interest rates in their headquarter state to customers throughout the nation.
Consumer advocates say banking regulators in Delaware and South Dakota have become industry champions rather than watchdogs. Delaware Bank Commissioner Robert A. Glen did not return repeated phone calls inquiring what his agency is doing to police or curb abusive practices of the major credit-card banks based in his mid-Atlantic state.
Due to limited government oversight, neither regulators nor industry analysts have the means to determine the degree to which lenders are taking customers to the highest default rates allowed in cardholder agreements accepted at the time of application.
The default rates typically are set at the prime interest rate -- currently 7.25% -- plus an added percentage of up to 25%. But issuers can jack rates much higher when card agreements expire, typically two years from the issue date.
The New York State Banking Department has been fielding more than 50 complaints a day recently from credit-card customers, mostly about steep interest-rate hikes, agency spokeswoman Jacqueline McCormack said. The department lacks the authority to do anything about them, she said.
Industry analysts said they'd be surprised if banks are increasing hair-trigger repricing, but acknowledged that rate repricing is the only means they have to manage risk with existing customers.
"Credit-card issuers are tightening standards. They are on red alert," said Scott Valentin, a banking analyst with Friedman Billings Ramsey.
"I'd be surprised if they're resorting to hair-trigger repricing on a widespread scale with all the political scrutiny on them," said Curtis Arnold, founder of cardratings.com. "It would be crazy for them to start engaging in such egregious activity en masse when they're already under the gun."
Long criticized for regulatory laxity under former Chairman Alan Greenspan, the Federal Reserve is proposing that cardholders get 45-day notice of a rate hike, with the option to cease charge activity and retire the balance at the existing interest rate. Banks currently don't have to give any notice and some backdate punitive rate hikes to the start of the last billing cycle.
U.S. Sens. Carl Levin, D-Mich., and Claire McCaskill, D-Mo., introduced the Stop Unfair Practices in Credit Cards Act in May following an investigation and hearing by the Permanent Subcommittee on Investigations, which Levin chairs. Among the act's provisions: A limit on penalty rate hikes of no more than 7 percentage points.
Rate hikes could apply only to future credit-card debt and not to debt incurred prior to the increase.
A prohibition on "pay to pay" fees when cardholders make a payment, whether by mail, telephone, electronic transfer or otherwise.
A requirement that payments be applied first to balances with the highest interest charge and not the lowest as is now the general practice.
The overriding issue is the unchecked hand lenders have to change terms virtually at will, said Maloney, who is preparing to introduce reform legislation in the House subcommittee she chairs.
"Disclosure isn't enough to protect consumers when the issuer can change terms of the contract at any time and in any way," Maloney said. "Many issuers can and do change the interest rate, the penalties, over-limit fees, how rates are calculated, the payment date and many other features."
For now, the lone recourse for those hit with high default rates is an appeal to the lender to rescind the hike if they have a solid account record. Citibank's Wang encourages just that: "If a customer believes he or she has been treated unfairly, we strongly encourage the customer to contact us directly."
Chris Pummer is a former senior editor for MarketWatch and Bloomberg News and a former reporter for such papers as the Los Angeles Times and San Jose Mercury News.