Editorial Policy

Penalty APRs Can Make Your Interest Rate Spike

Marcia Frellick

September 27, 2012

You may be proud of your low-interest credit card now, but if you're not careful, that low APR could be jacked up so high it'll make your head spin.

What will trigger this drastic APR rise to about 30 percent is if you break the rules in your card agreement by going over your limit, paying late or bouncing a check.

Penalty APRs can be applied to future purchases — or to the balance already on your card if you are 60 days late with your minimum payment.

Here's what to know about penalty APRs and what to do if you trigger yours.

Protections from the CARD Act
Thanks to the Credit CARD Act of 2009, it's harder to trigger penalty APRs, also known as default rates. The Act added several protections that make them less likely to happen and less punishing. For example:

It's harder to go over your limit: Cardholders now have to opt in to the ability to charge over their credit limits. Unless you have told your bank you want overdraft protection, which consumer advocates advise against, your card will be declined if you try to make a purchase that kicks you over the available credit.

You have to be very late to trigger a penalty APR on existing balances: You have to be 60 days late with your minimum payment to trigger the penalty APR on an existing balance. So, if you miss one payment, you'll be able to keep your low rate on your existing balance.

Before the Act, “if you missed a payment, they could get you the next day,” says Linda Sherry, spokeswoman for the advocacy group Consumer Action.

You get 45 days' notice of an increase on future balances: If your card company plans to increase your interest rate on future purchases because you have broken the rules, or for any other reason, it has to let you know why, in writing, 45 days in advance. There's a big catch, however: The higher rate kicks in on purchases you make 14 days after the notice was postmarked, though you have 45 days to decide if you want to accept the APR increase and keep the card open.

Why? During negotiations for the CARD Act, issuers argued to Congress that giving consumers a 45-day warning and a 45-day period before raising the rate on new purchases would invite them to charge up a storm.

“Maybe they've been on the fence about purchasing a big-ticket item and they hear that their interest rate's going to double,” Sherry says. “They might go out and charge up to the credit limit.”

Issuers, which don't want you to rack up debt you can't pay off, didn't want people charging up their cards, Sherry says, so they argued for narrowing the window to 14 days.

Defaulting on one card doesn't mean you'll automatically get penalized on all cards under that issuer: In the past, if you broke the rules on one card or even a utility bill, all issuers could penalize you by raising rates on existing balances.

What the CARD Act did was limit this “universal default” for existing balances. Different cards are different accounts, and even if they have the same issuer, the default rate doesn't spill from one to the other, says Beverly Harzog, independent credit card expert and consumer advocate.

However, Sherry notes, issuers can still see on your credit report that you have defaulted with another creditor and may decline your application for a different card or offer you a higher rate.

What to do if you break the rules
Just because issuers can legally charge penalty APRs doesn't mean they will, says Jana Castanon, education specialist for Apprisen credit counselors. She says most creditors are currently looking for other ways to reduce risk, such as reducing customers' credit lines.

“Credit card rates are already pretty high,” Castanon says, “so they'd rather reduce the amount of available credit.”

It's up to the issuer whether to charge retroactively if the customer is 60 days late with payment, Harzog says. Most will do this, she says, but that's not universal. Bank of America, for instance, states that it will not re-price (increase the APR on) existing balances, even if a payment is 60 days or more late.

If you do get a notice that the penalty APR will be applied, you have some options:

Cancel the card: If the rate is being applied to an existing balance because you are 60 days late, you have 14 days to pay off the balance at the old rate before the new rate is applied retroactively, Harzog says. Of course, most people who haven't paid for 60 days are unlikely to be able to come up with the cash to do so.

If you triggered the rate for a reason other than a late payment, the penalty APR would not be applied to your existing balance. So, you could cancel the card and pay off the existing balance over time at the lower rate. If you do that, however, your credit card company may increase your monthly payment and require you to pay off your balance faster than the terms of your agreement state, according to the Federal Reserve.

Think long and hard before you close a card, Harzog says, because that will lower the amount of available credit you have, possibly impacting your credit score.

Try to transfer the balance: You could try to transfer the balance on the raised APR card to another card offering a lower rate, but once you trigger the penalty rate at one bank, “it's highly unlikely another bank is going to want to take your transfer,” Sherry says.

Pay on time for six months and have your rate reconsidered: The CARD Act added this second chance, and consumer advocates say this is likely your best bet. If you have triggered a penalty APR because of a late payment, the credit card company has to automatically re-evaluate the rate if you make six consecutive monthly minimum on-time payments.

Note that issuers are required only to review your rate, Harzog says.

“There's nothing in the CARD Act that says they have to give you back your original rate or even a lower rate,” she says.

Sherry recommends that consumers check back with the issuer to make sure it's reviewing the rate at the six-month mark and ask if the rate will be lowered.

Avoid delinquency in the first place
Of course, the best way to avoid penalty APRs is to not let your account get behind.

You can set up email or text reminders through your bank or on your own that will remind you ahead of time when bills are due. Also review your account frequently online to stay on top of your current balance and next payment date.

If remembering to pay is a problem, Sherry recommends having automatic minimum payments deducted from a checking account. Yet paying only the minimum this way is not the best solution for two reasons: You're paying only the minimum when you should be paying as much as possible, if not the entire balance on the card. Also, having minimum payments automatically deducted does not help you develop good money-management skills if you continue to accumulate debt on your cards.

But, “if you're clueless enough to miss 60 days … then you need the belt and the suspenders,” Sherry says.