On Thursday, US regulators should vote on proposed rules to dramatically change several controversial business practices. As a former credit card marketer, I’m all for reform that will lower the interest burden and get borrowers out of debt. However, as well intentioned as this seems, it may end up being a case of “be careful what you wish for.”
First, let’s take a look at some of the proposed changes likely to pass:
- End double-cycle billing, which averages out the balance from two previous bills
- Provide reasonable amount of time to make payments
- Clearly list the time of day that a payment is due
- Clearly identify any changes to accounts would in bold or by listing separately
- Apply payments to higher-rate balances first, to reduce interest penalties and fees
- Prohibit banks from raising interest rates on existing card balances as long as a customer doesn’t fall more than 30 days behind on payments
- Eliminate universal default policy which allows card issuers to increase the rates on one card if a customer misses a payment on a different card.
Don’t get me wrong, some of these are unambiguously good. Providing more clarity on terms and billing policies clearly increases transparency and will benefit borrowers. However, some of the others might have consequences that borrowers may not have realized came along with the reform.
Applying payments to highest interest balances first may effectively kill balance transfers. From a bank’s perspective, the point of the balance transfer is not to give you an interest-free loan because they love you-it’s to encourage you to transfer your balance to their card and to charge it, incurring finance charges on new purchases. By applying payments to the new purchases first, the regulation will keep banks from making any money at all on a BT in the short term.
Under current universal default policies, lenders can hike interest rates if the borrower misses a payment or is late on another card. This sounds horribly unfair to the borrower. After all, it was on a different card. However, from the lender’s perspective, a borrower who misses a payment on a different card is more likely to default on the loan that the bank made to him. From that lender’s perspective, he just became a higher default risk even though he defaulted on a different card. Increasing interest rates is the lender’s mechanism for compensating for the now-higher risk. By eliminating this flexibility to deal with risk after the loan is made (which lowers risk for the lender), lenders will charge higher rates up front or may not make the loan at all.
Although the reforms seem simple, the impacts will be deep, dramatic, and may not be welcome for all borrowers. “We think it’s really going to mark the beginning of the new marketplace for credit cards,” said Edward Yingling, chief executive of the American Bankers Association, the industry’s biggest trade group. “It will in some fundamental ways change the product.”
Borrowers may indeed find that some changes are like medicine: good for you in the long run, but nasty-tasting going down.
Scott Crawford is CEO of DebtGoal.com, a do-it-yourself system for getting out of debt and lowering your interest costs. DebtGoal.com incorporates all of the techniques discussed in this post and can help users understand and get visibility to and manage their debt finances.
