The (Welcome) Aftermath of the Credit Card Reform Act of 2010

An oft-debated component of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA) was with respect to the consumer protection from credit card abuses.  Unfortunately, many of the recommended protections were left out of the final version of the bill, and it took 5 more years for Congress to revisit the need for those protections.  Given the public outcry over the economic meltdown, and the venerable banking institutions behind it, the credit card lobby no longer wielded the muscle which had prevented the implementation of these safeguards in 2005.  As a result, the Credit Card Reform Act of 2010 came to the aid of consumers, after more than a decade of reported abuses by the credit card industry as a whole.

Before I discuss how the safeguards have assisted consumers, it is important to provide a highlight of key provisions of the act:

–          With a few exceptions, credit card companies were required to give consumers 45 days’ notice of any changes in interest rates or other material terms of the cardholder agreement.  This gives the consumer the option of closing the account, and making payments based upon the existing contract.

–          With a few exceptions, the credit card companies could not increase the interest rate within the first 12 months of issuance of the card.

–          Credit card companies must submit bills to consumers no less than 21 days before the due date.  This prevents credit card companies from creating an opportunity for a payment to be received late, and generating additional charges.

–          In response to one of the most common complaints of cardholders, interest rate increases only applied to new purchases, and could not be applied retroactively to existing balances.  In addition, payments must be applied first to charges with the higher interest rates, rather than to balances at the lowest interest rates. (there are exceptions for charges made under a deferred payment plan)

–          Recognizing that college students were becoming increasingly targeted by credit card companies, even though the majority of them had no independent source of income, the law requires that anyone under the age of 21 must either have a cosigner for the card, or demonstrate that they have sufficient income to make the payments.

–          Billing statements must disclose the expected repayment period if the consumer makes only the minimum payment (assuming no other charges are made).  In addition, they must also disclose the amount of the monthly payment necessary to pay off the balance within 3 years.

The 45 day notice requirement regarding any material changes was long overdue.  Many times consumers did not find out about changes to their account until they received a bill.  In addition, continued use of the credit card was deemed to be consent to the changed terms, even if the consumer was unaware of the changes.  Basically, this was a classic contract of adhesion, where one party (the credit card company) dictated the terms to the other party without any opportunity for negotiation.   While the advance notice of the changes is helpful, it may not assist a consumer who only has one credit card, and would have to apply for another one.

The prohibition against interest rate increases in the first year was directed at companies that offered “teaser” rates to consumers in order to induce them to transfer balances from other cards that presumably had higher interest rates.  The low “teaser” would only last for 6 months (or even less in some cases) at which time the rate could be increased.  Even worse, the low “teaser” rate may have only applied to the balance transfer, and subsequent charges on the account may have been billed at an interest rate that was actually higher than the balance on the previous card.  In fairness to the credit card industry, these terms were often included in the application, but were so buried in miniscule fine print that the average consumer would have been hard-pressed to find and understand it.

Most credit card companies provided consumers with ample opportunity to pay their bills, but there were some who endeavored to make prompt payment as difficult as possible for their customers.  For some credit card companies and banks, late fees and over-the-limit fees represented a majority of their profits.  By providing an inadequate amount of time for consumers to mail in payments (often at addresses across the country), the credit card companies made it more likely that payments would be received late, thereby triggering late fees on average of $29 per month.  Also, a late payment could provide the company with an excuse to raise the interest rate, further increasing the profits on the account.  Given the proliferation of online banking, the significance of this change is slowly diminishing.

While credit card companies maintain the right to increase the interest rate based on certain occurrences (such as a payment default, provide the minimum 45 day notice is given), they can no longer apply the higher rate retroactively to the existing balance.  In my opinion, this has probably generated the most savings for consumers.  Imagine buying a carton of milk for $4 at the grocery store, and then being told 2 days later that you needed to pay another $1 because the price had risen.  Essentially, this was what the credit card industry was doing when it raised the rates on all balances.  While this policy defied all the basic elements of contract law – where a consumer should be responsible for the terms of the contract at the time of purchase – it persisted for years.  The new law especially protects someone who may have a high credit card balance at a low rate, as an interest rate increase on the entire balance could easily accelerate the monthly payment well above their ability to repay.  Many of my clients were propelled into default, and eventually bankruptcy, when rates were increased in such a manner.

The follow-up to the prohibition on retroactively applying higher interest rates to previous charges deals with the apportionment of payments.  Even if credit card companies could no longer raise the interest rates on existing charges, they would still apply payments to the balances with the lowest interest rates first.  This would allow the charges made at higher interest rates to continue to accumulate interest at the higher rate.  Now, credit card companies (with exceptions for specific purchases) are required to post payments to the charges at the highest interest level first.  This means that consumers receive the biggest “bang for their buck” when paying on credit card accounts with varying levels of interest.

The Credit Card Reform Act also required that persons under the age of 21 cannot receive a credit card without either a cosigner, or proof of income sufficient to make the payments.  Many credit card companies targeted college campuses, recognizing that college students would often be in need of credit, and presumably would have the income after graduation to make the payments.  Of course, the darker logic behind the policy of extending credit to students with no income was that their parents would eventually step in to pay off the cards to protect their children’s credit, in the event of a default.  Many companies paid for the exclusive right to market their cards on specific campuses.  I am reminded of a client that I met with years ago who had graduated from college with credit card debt beyond his ability to repay.  While in the college cafeteria eating lunch, he dropped a piece of pizza on his shirt.  Not wanting to go to class with a pizza stain on his shirt, he went to a table in the cafeteria where students were taking credit card applications.  By applying for a card, he received a free t-shirt, which he then wore to his class.  If not for that random event, he said that he never would have even thought of applying for a credit card while in college.  Now, he might have received the t-shirt, but he would not have received the card without a source of income.  Also, by requiring a cosigner, it prevents the student from spontaneously applying for credit card, and also allows a parent who does cosign the opportunity to monitor charges and payments on the account.

The last change which I described is with regard to the mandatory notice that credit card companies are required to provide about the amount of time necessary to repay a credit card balance based on the minimum payment.  This was one of the provisions that the credit card industry fought for so long, and with good reason.  While it is not necessarily a consumer protection, it certainly has been very educational for consumers.  It motivates them to pay extra money on their accounts, which reduces the interest that credit card companies receive.  It also allows consumers to prioritize among their credit cards, to determine which should be paid off first.  It also provides feedback to consumers when their interest rate changes, and they can see the difference it makes in the repayment term.  Finally, and probably of most concern to the credit card companies, is that the repayment term requirement can often allow someone to see the futility in simply making the minimum monthly payment, especially when the repayment term is 10 years or more.  This is especially common among elderly and/or retired consumers who are on a fixed monthly income, and lack the ability to pay more than the minimum monthly payment.  They cannot see the “light at the end of the tunnel” with respect to their credit card balances, despite their best efforts.

The backlash from the credit card industry has mostly subsided.  Most of the punitive measures exacted upon consumers by credit card companies and banks took place in anticipation of the implementation of the Credit Card Reform Act.  Many consumers saw their credit limits reduced, or charging privileges eliminated entirely.  Others experienced interest rate hikes on open accounts.  But since the Act has taken effect, the consequences have been minimal.  Many companies are not willing to offer the credit limits that they have in the past, and some have eliminated perks that were commonly available.  More documentation of income is generally required in the application process, although it is still less than required for the extension of other forms of consumer credit.  All in all, the credit card industry seems to have adapted well to the additional regulation, and there is no question that consumers have benefited in the manner that Congress intended.  However, consumers still have to be mindful to monitor their accounts, and carefully read any notices that are enclosed with monthly statements, so that they are in a position to utilize the protections afforded by the Act.