See if you can believe this. Imagine that you have two credit cards, a green one and a blue one, each issued by a separate bank. You're good about paying your bills on time, but one month, for some reason, you're late with your payment to your green card. Well, credit card issuers aren't in their business just for our convenience. They're there to make money, so your green card's rate is suddenly raised, per the fine print in your card agreement. It might even be raised all the way to the card's default rate of 30%!
That's pretty lousy, but things can get even worse. The next thing you know, the interest rate on your blue card is also hiked, even though you've always paid those bills on time. What happened? It's called "universal default," and roughly half of all banks have universal default policies in place on their credit cards. It means that one mistake with one creditor can result in significant rate hikes from lots of your other creditors.
Can it get any worse than that? Sure it can. It's not just late credit card payments that can trigger a universal default. If you have an unpaid library fine and it ends up going to a collection agency, that can appear on your credit record, and bingo -- big rate increases due to universal default.
If you're about to go over your credit limit, you might think that your credit card will just deny the charge that would put you over the top. That doesn't necessarily happen. Surpassing your limit can result in universal default -- as can bouncing a check or receiving a new credit card. In fact, simply having too much debt or just applying for a loan can trigger it.
The average default interest rate for credit cards was about 30% in 2004, with many rates now in the 35% territory. Here are the rates for several major banks as of August 2005, per CardWeb.com:
Bank of America
- Providian: 30%
- Morgan Stanley's Discover: 26%
- Bank of America's MBNA: 20%
To appreciate what these rates mean, imagine that you owe $8,000 on your credit cards, a not-so-unusual sum. If your interest rate, on average, is 15%, you'll be paying $1,200 per year in interest, a rather significant sum. But if that rate gets hiked to 30%, you'll be paying $2,400! For many people, their debt will start increasing as they find it harder and harder to pay off debt at the new rates.
If you (or anyone you know) are trying to dig out from under debt, visit our Credit Center, which features some surprisingly interesting info about the credit card industry and tips on getting out of debt. (You might also be interested in our own Fool Visa card, which is so snazzy that it also serves as a conversation piece.)
The good news is that some lawmakers have been looking at this practice and frowning. We may see less of it in the future, if some recently proposed legislation doesn't languish and die. In the meantime, pay your bills on time!
Longtime Fool contributor Selena Maranjian does not own shares of any companies mentioned in this article.