Reforming the Credit Card Industry

Last Updated Apr 15, 2009 8:29 PM EDT

The Federal Reserve lowered the boom on credit card companies last December with new regulations that take effect 18 months later. Among the rules, banks generally won't be able to raise your rate in the first year an account is opened or use two-cycle billing, which bases the rate on a cardholder's average daily balance over two months, instead of one.

Despite these reforms, many consumer advocates believe the Fed failed to complete the job. Representative Carolyn Maloney (D-N.Y.) and Senator Christopher Dodd (D-Conn.) introduced bills to make the Fed's regulations go into effect sooner. They and consumer groups including Consumers Union, the Consumer Federation of America, the Center for Responsible Lending, and the National Consumer Law Center also think the following reforms are needed to make credit cards fairer for consumers.

1. A national usury rate

Consumers should not have to pay extortionate interest, like the penalty rates charged to nearly half of cardholders with revolving balances. Senator Richard Durbin (D-Ill.) has proposed a maximum annual percentage rate (APR) of 36 percent.

2. Truly “fixed” rates

Card issuers say they must adjust rates to reflect the shifting creditworthiness of their customers. But funny thing: they never lower your rate when you become more creditworthy. The Fed’s rules require fixed rates to stay fixed for the first year. But banks should be required to keep rates fixed for another year or two, depending on the customer’s credit score. If the score drops after year one, the card could expire in three to six months and the issuer could then cancel the card or raise the rate.

3. Rate hikes confined to future charges

A card issuer can apply a new, higher interest rate not only to future purchases but to existing balances, too. “Banks should not be able to change the rate retroactively,” says Joshua Frank, senior researcher with the Center for Responsible Lending.

4. A “hard” credit limit

Why do card companies set a credit limit if they let customers exceed it — for a fee of $39 or so? Issuers say they offer the loophole because they don’t want consumers to be embarrassed having a charge publicly declined. But many customers would appreciate the turndown, rather than a steep surprise fee.

5. An end to universal default

Credit card issuers should be prohibited from raising a customer’s rate just because he was late paying another bill.

6. No more soliciting students

To keep students from graduating with thousands of dollars in credit card debt, banks should be prohibited from soliciting them.

7. Redemption from default-rate hell

Consumers should not be required to live with a 25 to 30 percent penalty rate forever just because they default on their cards by missing payments once or twice. If a cardholder pays his bills on time for six months or so after a default, the issuer should reward him by lowering his penalty rate.