Credit Card Interest Rates and Universal Default

by Tom Fragala   

We've all seen the "fine print" on our credit card agreements, although we rarely read it. Well, after you learn about a credit card industry practice called "universal default," you may wish you had read — and understood — the fine print.

Starting in the 1990s, credit card companies started including language in credit card agreements for something called "universal default." This term means that the card-issuing bank increases the interest rate on an account after it learns you have defaulted with another, different credit card or lender. It finds this out by periodically pulling your credit report to examine your payment history with other companies — without your knowledge. In other words, even if you've never had a late payment on Credit Card A, if you default or pay late on another credit card or loan, your interest rate on Credit Card A can go through the roof. Sometimes the rates increase to over 30 or 40%!

Is this legal? Yes it is, even though several bills have appeared before Congress to stop this practice. The reason credit card companies adopted this practice is because they use "risk-based pricing," and they believe the interest rate of the loan should reflect the risk of the borrower.

Needless to say, consumers are enraged by the practice, and it is the #1 complaint to lawmakers. One of the criticisms of the practice is that people who hit a temporary financial rough spot, and unavoidably default on one credit card or loan, could suddenly find themselves in a vicious cycle where they get hit with terribly high interest rates on all their credit cards, resulting in further defaults. Their credit score and entire financial standing could be ruined by one unpaid credit card bill.

Another serious concern is identity theft or fraud, which often results in reports of a card default and unpaid loans. The victim in this case not only has to deal with ID theft cleanup, but even credit accounts that are untouched and fully paid could see sky-high interest rates. Talk about double dipping!

There is some good news. First, you can search your existing credit card agreements to see if your issuer has a universal default policy, then get another card to use if they do (closing your account may hurt your credit score, though). Second, armed with your newfound knowledge of universal default, you can avoid opening credit cards from such card issuers. Third, some large credit card companies have voluntarily stopped the practice, including Citibank, and JPMorgan/Chase.