Are Universal Default Clauses Making a Comeback?

by Tom Fragala   

In reaction to the 2008 credit crisis and overall economic strife, many credit card issuers are planning to or have already taken serious measures, such as raising credit card rates and reducing balance limits. Many credit card customers have had their credit limit lowered or seen an APR increase without warning.

Well, there appears to be one more particularly nasty surprise lurking around the corner. Just when you thought it couldn't get worse, leading credit card issuers appear ready to relaunch the controversial "universal default."

Universal default is a policy that was commonly found in the terms and conditions of credit cards in the past. Credit card companies regularly review their existing cardholders' credit reports, looking for any changes that might make you a greater credit risk. If they detect anything they feel is negative — even if it's not related to your account with them — they can:

• Increase your balance interest rate (APR)
• Increase your cash advance interest rate (APR)
• Reduce your card limit
• Charge account closing fees if you decide to cancel

Consumers are often shocked to learn that their credit card companies are scanning their credit reports without their knowledge and taking drastic action — even if they've been a good customer for years.

Here's an extreme example. You have a credit card account at Bank A with a balance of $3,000, a credit limit of $5,000, and a 14% interest rate. You also have an auto loan at Bank B. Let's say you miss a payment, totally by accident, with Bank B. Bank A discovers this by scanning your credit report, then notifies you without warning that they're reducing your credit card limit to $1,000 and raising your interest rate to 30 percent. Because your limit was reduced, you're automatically over the limit and must pay the $2,000 difference immediately — with the punitive 30% interest rate kicking in on the balance. If you don't pay off the $2,000 right away, you get a derogatory mark on your credit report, reducing your credit score. If you do pay it off somehow, you're still locked in at the 30% rate on the remaining $1,000 (unless you pay that off too). You can see why consumers might get a bit upset at this practice.

Credit card companies argue that this is not meant to harm customers but is to protect the company from potential losses of customers who are getting far riskier. They figure that if you're having trouble paying off a loan or credit card at another creditor, sooner or later you're going to default with them.

Some of the things that can trigger universal default include:

• Late payments on any credit account
• Too much overall debt (too many credit cards/loans are open)
• A low debt-to-credit ratio (too many high balances)
• Too many applications for new credit accounts

In the past couple of years, before the credit crisis, lawmakers and consumer advocates started to put the heat on credit card companies for a number of practices, including universal default. The pressure was so great that some large credit card issuers, i.e., Citi and Chase, voluntarily promised — while testifying before Congress — to stop the practice.

In fact, as the US PIRG blog said recently:

The questions remain whether Citi is going back to "universal default" and whether it plans to break any previous "a deal is a deal" promises to U.S. Senator Carl Levin (D-MI) and accountholders. As Citi testified before Senator Carl Levin's Permanent Subcommittee on Investigations in March 2007:

"Citi will consider increasing a customer's interest rate only on the basis of his or her behavior with us — when the customer fails to pay on time, goes over the credit limit, or bounces a checks."¹

It's no secret what's inspiring the potential comeback of universal default. Charge-offs due to defaults are increasing among all credit card issuers. More and more delinquencies are being reported by banks and department store card issuers. Therefore, as they face having to write off more bad debt, they're looking for ways to increase revenue.

What can be tricky about universal default is that your original terms and conditions may not even mention it. The card issuers can legally add it anytime and bury the language in the fine print of a "notice to cardholders."

Make sure you read everything you get from your credit card company, and be vigilant about paying all your credit bills — not just your credit card bills — well in advance of the due date. Remember: Your credit card company could be watching.

Footnotes
¹ "Citi to jack credit card rates (oops, I mean "re-price")," U.S. Public Interest Research Groups