Penalty Rates Creep Higher, But Become Rarer

Credit card companies have long penalized late payers with a painful one-two punch. In addition to slapping customers with pricey one-time fees, they often pile on punishing penalty interest rates (often topping 30%) to the balances.

The 2009 Credit Card Accountability, Responsibility and Disclosure Act (CARD Act) was designed to soften the blow. It limited when penalty rates could be applied, and created "cures" to help people get out of the penalty box.

New research compiled by indicates that results of the new law on the penalty rates have been mixed.

  • On one hand, many cards no longer have a penalty rate. In's 2010 survey of penalty rates, 91% of the cards researched charged a penalty rate. In 2011, that percentage fell to 69%.
  • But the cards that kept a penalty rate showed no signs of generosity: The average penalty rate jumped from 27.9% to 28.6%. The median rate also jumped, from 28.9% to 29.4%.

For Linda Sherry, director of national priorities at Consumer Action, a small bump in penalty rate is worth the other benefits that consumers have experienced. "Penalty interest rates have always been objectionably high, and they were applied [too liberally]," she says. "Overall, though, consumers are in a better position today."

Details of the survey

To calculate the penalty rate average, surveyed the annual percentage rates (APRs) listed for about 100 online credit card offers from a variety of issuers, ranging from major banks to subprime lenders. The cards were chosen to reflect the cards in greatest circulation in the United States. Lenders that did not charge a penalty rate were not included in calculating the average. In instances where the card offered a range of default APRs, we included the highest APR in that range.

HSBC has long held the dubious distinction of having the highest penalty rate of all lenders (last year, it was 31.99%), but it dropped penalty rates. The top rate now belongs to Barclays, which offers at least four cards (Apple Barclays, LLBean Visa, Visa Black and Wyndham Barclay Visa Signature) with penalty rates of 30.24%. Barclaycard U.S. spokesman Kevin Sullivan says that penalty rates are just one piece of the credit card puzzle. "There are several elements [to every card], such as core features, rewards and service," he says. "These elements are managed in concert."

At the other end of the spectrum is PenFed, which offers five cards (PenFed Visa Platinum Cashback Rewards, PenFed Premium Travels Reward, PenFed Visa Classic, PenFed Visa Gold and PenFed MasterCard) with a 17.99% penalty rate. PenFed spokeswoman Amy Doane says that the rate is no accident. "Federal credit unions have a current interest rate ceiling of 18% on all loans, [which] is established by the Federal Credit Union Act and the National Credit Union Administration regulation." She adds that the low rate is in line with the core principles of credit unions. "It ties in nicely with our general philosophy of minimizing fees to our members. We are continually looking for ways to reduce fees even further," she says.

Finally, there are the 30 cards that have eliminated penalty rates altogether, which include offerings from Wells Fargo, HSBC and U.S. Bank, among others. According to Wells Fargo spokeswoman Lisa Westerman, the company eliminated a number of fees, including penalty rates, in 2010. "Our intent," she says, "is to continue to provide credit to as many customers as possible."

Lenders may have removed that particular punishment from their arsenal, but that doesn't mean that late payers will get off scot-free. Among the potential consequences are penalty fees, slashed credit limits, account closure and serious damage to a customer's credit report.

CARD Act 'cures'

Before the CARD Act was passed, one common complaint among consumers was that a penalty rate was often applied quickly and was often difficult (if not impossible) to reverse. The CARD Act created new rules regarding the application of a penalty rate, and created "penalty rate cures" that allow a consumer, after a period of on-time payments, to reverse the penalty rate.

The CARD Act stipulated that a penalty rate could only be applied after a cardholder is 60 days late with a payment, which has all but eliminated the problem of an otherwise responsible cardholder who misses a single payment getting stuck with a high penalty rate.

When a penalty rate is applied after 60 days, the CARD Act stipulates that a cardholder can still redeem himself or herself. Cardholders who pay the next six payments on time can earn back a lower rate. A third missed payment, however, will cause cardholders to lose their shot at a lower rate.

Lauren Bowne, a staff attorney for Consumers Union says the new rules are a good start, but they're not enough. "If people are missing two payments, it's usually because they're having financial difficulties -- maybe they've lost a job," she says. "That doesn't mean after six months, when they settle their financial situation, that they might not go on to pay on time for years after that. To us, that's a big loophole, and protections should be expanded."

Lenders may offer more lenient terms than called for by the law. At Pen Fed, for example, penalty rates are removed after just three consecutive on-time payments.

Bowne adds that she'd also like to see penalty rates receiving the same kind of scrutiny that penalty fees have seen. In the CARD Act, for example, penalty fees must be "reasonable and proportional" to the delinquency. That is, a cardholder who is one day late shouldn't be punished as harshly as a one who has missed three months of payments. The same is not true of penalty rates. "Credit card companies can set penalty rates as high as they want, and that's something that still needs to be addressed," she says.

A final, but indirect, benefit of the CARD Act for penalty rates was in all but eliminating one of the three penalty rate triggers. Penalty rates are most commonly caused by late payments, but they can also be brought about by paying with insufficient funds. A third trigger, going over the stated credit limit, became all but impossible when the CARD Act required consumers to opt-in to over-limit fees (if they do not, the charge will simply be declined).

Overall, consumers overall have noted the benefits of the CARD Act. A survey by the Consumer Financial Protection Bureau showed that 57% of those familiar with the CARD Act says that it's been personally beneficial to them.

"There's been a huge step forward," says Bowne. "But there's still room for more improvement and protection."