The following is an article reprinted with permission from the upcoming Spring 2009 edition of The WWR Letter:
By: Robert Rutkowski, Partner
The economy being what it is, any changes lenders try to make in the way they do business get magnified. Some lenders have been increasing their late fees and penalty rates. Now, penalty rates are nothing new: some financial institutions have had penalty rates for decades on credit cards. I’ll never forget the time, years ago, when I was in law school and I forgot to mail in my credit card payment one month. Accordingly, the payment was a little late. Back then, like many students, I had at least three credit cards and I used them to make ends meet while I was in school. At that time, I did not belong to four credit unions like I do now. I only belonged to one. Of course I had a credit card issued by that credit union, but that wasn’t the payment I was late on.
Imagine my surprise when the interest rate on my tardy card went to 22%. I was furious. I knew that the card company had every right to do it, but it still made me mad. It also motivated me to get out from under it. As soon as I could, I refinanced out of it and closed the account. It took months, however, to do that, and every month I had to pay the higher interest rate made me angry. I never did business with that financial institution again. Penalty rates may generate high revenue, but they also generate enmity.
Many people have experienced this scenario. Or, people have experienced some sort of other unexpected rate change on a card and have had trouble refinancing out of it. The Federal Reserve Board addressed this issue recently through the new Unfair or Deceptive Acts or Practices (“UDAP”) rule. However, there is an exception for delinquencies more than 30 days past due (there are also other exceptions and some complicated notice requirements). The UDAP rule creates a “protected balance” on which the old rate must stay in place. The financial institution can amortize this balance over (no less than) five years and it can increase the minimum payment (up to double), but it cannot raise the rate. This new rule does not go into effect until July 1, 2010.
Meanwhile, back on Capitol Hill, Congress feels that UDAP is too little too late. The New York Times has reported that some have argued for a “Credit Cardholders’ Bill of Rights” (http://www.nytimes.com/2009/05/10/opinion/10sun2.html?ref=opinion). In any event, it is clear that Congress wants to restrict the ways in which financial institutions can raise rates on existing credit card balances and it wants to put this into place sooner than the time UDAP is to take effect. (Edit: and in fact President Obama has signed such a bill into law).
Of course, few credit unions charge penalty rates and Federal Credit Unions (“FCU”) are capped at an 18% interest rate anyway. So even if an FCU charged such a rate, it would not go past 18%. For credit unions interested in marketing their credit card portfolios, this is good news. A credit union can extol its low rates and lack of penalty rates to gain market share. The big changes happening in the credit card industry might actually be a boon to credit unions that want credit card business.
Robert Rutkowski is the Managing Partner of WWR’s Credit Union department. He can be reached at (216) 739-5004 or firstname.lastname@example.org.