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Vol. 16, No. 2

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A Shorthand Guide to the Credit CARD Act of 2009

As the result of legislation passed last year, Congress and the Federal Reserve have fundamentally altered the credit card business. President Obama signed the Credit Card Accountability Responsibility and Disclosure Act of 2009, PL 111-24, into law on May 22, 2009. The Federal Reserve announced its final rule implementing the Act on January 12, 2009.

The new law, known as the Credit CARD Act of 2009, prohibits a number of practices that consumer advocates have long challenged as fundamentally unfair. The Act’s two most notable restrictions significantly cramp the style of banks used to changing credit card terms on a whim.

First, the Act prohibits banks from increasing interest rates or fees without meeting certain criteria. Banks must now give at least 45 days’ notice of a proposed change, and offer the cardholder the right to cancel the account rather than accept the change. Second, banks now can’t increases interest rates, fees, or other finance charges during the first year an account is open.

Of course these two new restrictions on increases in rates and fees aren’t absolute. There are four specific exceptions:

1. Banks are allowed to impose a scheduled increase at the end of a promotional rate as long as the increase was disclosed at the beginning of the teaser period. The law also prevents the bank from applying any increased interest rate to transactions that occurred before the promotional rate period.

2. Banks may increase account rates if they use a variable interest rate that’s based on an index rate available to the public and not under the bank’s control.

3. Banks may impose an increase if the cardholder completes or fails to complete a hardship arrangement. In these cases, the bank must disclose the increased rate before the beginning of the arrangement, and the increase may not exceed the rate in effect prior to the start of the hardship arrangement.

4. Banks may increase a cardholder’s rate due to any failure to make a minimum payment, if the bank hasn’t received that minimum payment within 60 days after its due date. In these cases, the bank must give the cardholder notice that the increase will terminate if the cardholder makes the next six required monthly payments on time (and, of course, if the cardholder complies, the bank must then follow through by reducing the cardholder’s rate).

If the cardholder chooses to cancel an account rather than accept any change in terms, the bank may not change the payment terms governing the remaining balance on the account. Two exceptions here: a bank may require the account be paid off in no fewer than five years. A bank may also require a minimum payment based on a percentage of the account balance; that percentage may be no more than twice the percentage required before the notice of change.

The Act’s changes should eliminate two of the primary problems cardholders had previously faced: arbitrary rate increases and “gotcha” penalty rates imposed when a cardholder was a day late with a payment. However, there’s one potential “gotcha” in the new provisions: the term allowing changes in the amortization of cancelled balances could result in substantial increases in cardholders’ monthly payments if they choose to cancel their accounts rather than agree to the changes. Neither the statute nor the rules require banks to disclose the cancellation’s impact on the amount of the minimum payment due on the account, so canceling consumers may be surprised by these increases.

Other changes in the Act include new restrictions on over-the-limit fees effective February 22, 2010. Now, a bank may not charge an over-the-limit fee unless the consumer elects to allow it. Consumers must be notified on each monthly statement of their right to reverse this election, and banks are prohibited from charging such fees more than once in a billing cycle.

Banks are also prohibited from charging over-the-limit fees for more than two billing cycles unless the cardholder goes further over the limit with a new transaction or recrosses the upper-limit line after reducing the balance below the limit. And a bank may not charge an over-the-limit fee if an account goes over the limit solely because the bank adds interest or fees to the existing balance.

Under the Act, banks must allocate account payments in a more consumer-friendly manner. Before, if a cardholder carried multiple balances with different interest rates in a single account, banks typically applied payments to the lowest interest rate balances first, maximizing their profits and frustrating consumers who accepted promotional rate offers only to find that savings were offset by increased interest charges on existing higher balances.

Now, banks must apply any payment amounts over the minimum to the highest rate balance on the account. There’s an exception for deferred interest balances: during the last two months of the deferred period, banks must credit excess payments to the deferred interest balance. The new provisions also require banks to honor cardholder directions about the application of payments during the deferred period.

However, the new payment allocation rules’ benefit is significantly limited, because it applies only to payments in excess of the minimum payment. The law allows banks to continue applying the minimum payment amount to the lowest-rate balance first.

While the provisions I’ve covered here are the major changes that will affect most cardholders, the Act subjects banks to a variety of other new restrictions:

  • There are significant restrictions on marketing credit cards to college students and to anyone under age 21. Banks also are required to consider an applicant’s actual ability to repay before issuing a credit card.
  • Banks may no longer use double-cycle billing to increase finance charges to cardholders. Monthly statements must now contain educational disclosures comparing the cost of making only the minimum payment to the cost of paying off the balance in 36 months.
  • New provisions will make it easier for those settling estates to get payoff information and harder for banks to assess fees pending resolution of estates. There are new limitations to prohibit so-called fee-harvesting cards from charging fees (other than late fees, over-the-limit fees, and returned payment fees) in excess of 25 percent of the initial credit limit during the first year after an account is opened.
  • Starting August 22, 2010, the amounts of penalty fees, such as late payment fees and over-the-limit fees, must be reasonable and proportional to the omission or violation to which the fee relates. The Fed hasn’t yet issued rules implementing the restrictions and setting the amounts of penalty fees; it will do that in a separate rulemaking proceeding.

With the Credit CARD Act, Congress and the Federal Reserve Board have made the most sweeping changes to the manner in which credit cards are regulated in decades. The changes address long-standing complaints by consumer advocates about the banking industry’s most unfair practices. However, banks started gearing up for these changes since it became evident they would take effect—even before Congress passed the Act.

The industry implemented many rate and fee increases in advance of the new rules’ effective dates. Banks have great incentives to find new ways to ensure the steady profits that the old rules permitted. Whether the resulting credit card system will truly benefit consumers will depend to a great extent upon the banks’ ability to find new ways to extract revenues from cardholders.

Craig Jordan is board certified in consumer and commercial law and a former assistant attorney general in the Consumer Protection Division of the Texas Attorney General’s office. He is also a former chair of the Consumer and Commercial Law Section of the Texas Bar. Contact him at craig@warybuyer.com.

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