Most consumers know that your credit score affects the credit card rates that you are eligible for. What you may not know is that if your credit score is lowered, then the interest rates on existing credit card debt could increase significantly. How? Universal Default.
It's not a phrase that most are familiar with, and it's certainly not one that's used in day-to-day conversation. And although you may not even know what it means, it is very possible that you could learn about universal default any day now the hard way.
Buried in the fine print of the credit card terms and agreements, a universal default clause generally states that if you default (are late paying your bills) to the credit card issuer or any other lender the interest rate on the credit card could be raised. Banks that utilize the universal default clause periodically check credit reports of their cardholders. If a credit score is lowered for any reason late payments, high debts on loans, etc. then the universal default can be activated. Yes, even if you have a perfect bill-paying record with the card issuer.
According to Linda Sherry of Consumer Action, more banks than ever use universal default policies to increase interest rates based on their customer's credit performance with other creditors. Banks seem to be saying that if there is even a shadow of a doubt that a cardholder might not pay, they are going to get a premium on their money while they still can.
We (Consumer Action) believe the real purpose of these policies is to maximize revenue at the expense of those who are least able to afford it.
Taking a closer look
According to Linda, more issuers than ever use universal default polices to increase interest rates based on their customer's credit performance with other creditors. A study by Consumer Action illustrates a higher use of universal default than ever before. Out of 45 banks issuing 144 credit cards, 44% of those banks use a universal default clause. This is up from 39% in 2003.
Your credit card company might use the fact that your mortgage payment was delayed to justify a rate increase, notes Sherry. While your card company has always checked your credit on a regular basis, it's now coming down hard when it senses a negative change in your credit.
Sherry continues, What is usually not mentioned, but is eye-opening indeed, is that banks are not issuing these new rates on new charges only the entire balance is subject to the higher rates.
Gerri Detweiler, founder of DebtConsolidationRx.com, agrees. Universal default has become one of the leading reasons that she gets calls from consumers these days. While universal default has been around for years, more banks are using it and its use has gained momentum over the last five years.
The current legislation regarding bankruptcy could significantly worsen the impact of universal default for cardholders should it pass, Detweiler continues. Consumers want to pay back their debts, but when their interest rate is so high, their efforts seem fruitless.
Why do banks utilize the universal default clause?
In its groundbreaking program Secret History of the Credit Card, PBS' Frontline posed this question to credit card executives. According to their interviews, executives relayed that the bank is not being unreasonable in raising rates when it has reason to believe that the risk of being repaid by the customer has increased. In other words, they are protecting their interests by balancing their risk which means higher interest rates for high-risk borrowers. One troubling aspect is that the rules that determine what high-risk is seem awfully subjective.
What seems blatantly wrong with this scenario is the bank's ability to change its terms on money that's already been borrowed. For example, say you recently purchased a product using your credit card at an APR of 8.9%. Several months down the road you're informed that for whatever reason, your rate is now 27.99%. This new rate isn't just applied to new purchases. It's applied to the balance that you already carry on the card! Although seemingly a breech of contract, banks have disclosed their ability/intent to raise rates under certain circumstances so it's perfectly legal.
Many card holders don't know about the existence of the universal default until they're notified about a change in interest rates or many times until after it's already been changed. One victim of universal default who preferred to remain anonymous was confused when she noticed a significantly higher interest rate on one of her credit card statements. I called the bank but I received no additional information or help beyond being informed that my rate was raised.
Another unsuspecting consumer, Mary Ann, was surprised when she read her credit card statement one month to find that the APR had been raised from 8.99% to 18.49%. When she called the company, she was informed that her credit record revealed a high debt-to-income ratio, thus the bank had declared that her risk as a borrower had risen.
I consider myself to be very capable with my finances, says Mary Ann, but I've had a few years where I ran up more debt than usual, including a home equity loan. I made all of my payments on time, but evidently my new debt affected what used to be a stellar credit record. It's frustrating.
Soon after, another credit card bill arrived from Chase with a new interest rate of 27.4%--up from 8.9%. Another unpleasant surprise for Mary Ann, who said In all the years that I held this card, I never made a late payment.
Universal default strikes again! :0(
What your options are
Since most experts concur that it's nearly impossible to talk your way out of a universal default once it has been activated (although it wouldn't hurt to try), it's important to avoid having it triggered. How can you protect yourself against universal default? The two keys are to pay your bills on time and to avoid becoming what the banks consider a credit risk.
- Always make your payments on time. If possible, pay bills when you receive them instead of when they are due. Online bill paying is becoming an increasingly popular option for many consumers. Also consider using automatic or electronic reminders to help organize your bill paying. If necessary, try contacting your various card companies and ask to have your due dates changed so that they fall at a time of the month that coincides with your cash flow.
- Monitor your credit on a regular basis. Consumer advocates suggest that you check you credit reports at least once a year and checking your reports twice a year is not a bad idea. Similarly, you need to regularly check your credit score and educate yourself about the factors involved in credit scoring. Improving your credit score can help you avoid universal default and may result in significant interest savings, not only on your credit cards, but on other loans as well.
- Understand your card terms. First, make sure that your current credit balance is at a low rate. If your credit score is above 700, then you should be able to qualify for a good rate (a rate below 10% is considered attractive in today's market). Now that you are aware of universal default, re-read the terms of your credit cards looking specifically for a universal default clause tucked away somewhere. Since you usually can't talk your way out of universal default once it's been triggered, you should avoid holding a card that utilizes it. If you carry a balance on a card that utilizes universal default, you might consider transferring that balance to one that doesn't. Says Detweiler, if universal default has been activated on one card, a domino effect can result with your other cards following suit. After that happens, you may have trouble getting a low-rate balance transfer offer.
- Read your mail. We've become so accustomed to receiving credit card offers in the mail that many times they head straight to the shredder without being read. From now on, give those envelopes a precursory glance to make sure it's not one of your issuers relaying a change in terms. According to Mary Ann, she may have missed mail notification from one of her banks regarding universal default for this very reason. While this would not have prevented universal default from being activated, she would have been prepared for it and ready to strategize an action plan.
Being aware of what triggers universal default can definitely help prevent you from becoming another statistic. If you do become a victim, then consider utilizing a non-profit credit counseling service to help you deal with you debt situation. You can find out more information about such services and other related resources by visiting the credit card help section of CardRatings.com. Good luck!