The Federal Reserve last week released the long-awaited new credit card rules, which specify how the provisions of the Credit CARD Act passed by Congress in May of last year are to be implemented. In the new rules, which will take effect on February 22, the Fed takes aim at some of the new variable rate credit card tricks card issuers have introduced over the past year.
Since the law was passed, card issuers have been busy finding ways to minimize the effects of the new rules on their bottom line, hiking credit card interest rates and penalty fees and inventing new fees and novel, obscure tactics to extract money from cardholders.
Variable rate credit cards in particular have been a target for card issuers’ efforts. When the new credit card law steps into effect, card issuers will no longer be able to raise interest rates arbitrarily on existing balances. However, variable rate cards, to a degree, are exempt from this rule, since the interest rate on variable rate cards is tied to the prime rate, and hence will move up and down in sync with the prime rate. This fact has not been lost on card issuers, who over the past year have been hard at work turning existing credit cards into variable rate cards, making fixed rate cards almost a thing of the past.
Card issuers did not stop there, however. Some introduced a new term: “the variable rate floor,” which allows interest rates to go up in synch with the prime rate, but sets a floor on how low they can go down.
In addition, many card issuers introduced new ways of picking the value of the prime rate interest rates would be tied to. In the past, the interest on variable rate cards has been calculated by simply using the value of the prime rate on the last business day of the billing period. To inflate the interest rates on variable rate cards, however, card issuers introduced the so-called “pick-a-rate” practice, which sets the interest rate on variable rate cards to the highest level of the prime rate in the three-month period preceding the billing period.
The Center for Responsible Lending, which was one of the consumer groups to first raise concerns about the new pick-a-rate practices, estimates that pick-a-rate currently costs American consumers $720 million per year and predicts that the cost could reach up to $2.5 billion annually if the practice were allowed to spread.
In its newly released rules, the Fed responds to concerns about the new variable rate tricks raised by consumer groups. The Fed acknowledges that putting a floor on how low interest rates can go down is hurtful to consumers because, as the Fed states, “as a result, the variable rate can only increase, and the consumer will not benefit if the value of the index falls.” The Fed concludes that putting a limit on how low interest rates on variable rate cards can go will be unlawful under the terms of the new credit card law.
The Board also takes on the so-called “pick-a-rate” practices, which effectively prevent consumers from receiving the benefit of decreases in the index. The Board in its new rules bans card issuers from picking the highest rate during a given period, and instead specifies that the rate must be set according to the value on a pre-specified day, such as the end of a billing cycle, or adjusted according to the value of the average index value during a pre-specified period.
The Fed rulings come in response in particular to concerns raised by The Center for Responsible Lending and the Pew Health Group’s Safe Credit Card Project, which in an October 2009 study found that the use of floors for variable rate cards were on the rise among the eight largest credit card issuers. None of the major card issuers used the practice on most of their cards five years ago. The Center for Responsible Lending documented the new practices in its report of eight new sneaky credit card practices released last December.
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