Credit Card Interest Rates Under the Credit CARD Act

With the passage of the Credit Card Accountability, Responsibility and Disclosure Act of 2009 (“The Act”), Congress sought to provide better protections to consumers. As part of that effort, that legislation removed the “floor” interest rates on credit cards. The interest rate floor is set by the card-issuer as the minimum annual interest rate, and is the lowest possible rate available after any introductory period is over for an account. The majority of credit card accounts have a variable interest rate where the annual percentage rate (“APR”) is based on the prime rate plus a margin that rises and falls in lock-step with the federal funds rate set by the Federal Reserve, which is currently at 3.25%.

Under the Credit CARD Act of 2009, the Federal Reserve prohibits accounts with interest rate floors because the card-issuers are preventing rates from freely dropping as the prime rate falls.

While the Fed has trumpeted its new rule as a benefit to those consumers who have variable rate interest credit card accounts, this may be an example of the law of unintended consequences where consumers may actually end up paying higher interest rates. According to the Federal Reserve, credit card charge-off rates peaked at 10.25% in the 3rd quarter of 2009 and remained at 9.95% in early 2010. The card-issuer controls the initial index and margin, and cost of funds and other expenses require the card issuer to charge a minimum rate just to remain profitable. If the card-issuer projects lower future margin interest rates without the protection of the floor rate, it is likely that the card-issuer will raise the index or margin rate, resulting in higher costs to the consumer.

In the Fed’s quarterly survey of senior loan officers released in May 2010*, banks indicated they tightened their lending standards on both consumer and small business credit cards in the first quarter of 2010. With interest rates at historic lows, rates are unlikely to fall much further.

Over the past couple of years, many consumers complained that their rates were raised as a result of minor infractions, including one missed payment. The Act contains revisions that took effect on August 22, 2010, designed to remedy this issue, including a requirement that the credit card issuer re-evaluate the borrower’s interest rate every six months if the borrower’s rate was raised after January 1, 2009. Examining the same criteria used by the issuer to evaluate new customers (including creditworthiness, current market conditions and other factors), if these conditions have improved, the issuer is required to lower the rate. If the rate is not lowered, the card issuer is required to reevaluate the rate every six months indefinitely. If the issuer raises customer rates in the future, it is required to provide an explanation for the increase, such as changes in the customer’s creditworthiness or account behavior.

While these new provisions regarding allowable interest-rates are designed to protect consumers, their effectiveness is not assured; they may result in additional costs to consumers and may reduce the availability of credit to financially disadvantaged consumers.