Editorial Policy

Fed Closes CARD Act Loopholes, Sparking Controversy

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By Eva Norlyk Smith, Ph.D.
March 31, 2011

The Federal Reserve recently approved new rules that will close some of the loopholes in the Credit CARD Act of 2009 and strengthen its consumer protections.

However, critics argue that the new rules may disadvantage some consumers, including nonworking spouses. Here are highlights of the Fed’s amendments, which will go into effect on Oct. 1:

Interest Rate Traps Eliminated
Since the Credit CARD Act of 2009 went into effect, some card issuers have used clever loopholes to circumvent the CARD Act’s restriction against raising interest rates retroactively. In the past, one late credit card payment could be enough to trigger an interest rate hike on existing credit card balances and saddle cardholders with default penalty rates up to 29.99 percent.

Lawmakers tried to stop this practice by stipulating in the Credit CARD Act that interest rates can only be raised on existing balances if a cardholder is behind on payments by 60 days or more. However, card issuers got around this rule by offering cardholders who paid their bills on time waivers on interest charges (instead of offering them 0 percent APR promotions). Then, if the cardholder had one late payment, the issuer would eliminate the waiver and apply the standard interest rate — typically 20 percent or higher.

The Fed closed this loophole by requiring that interest waivers abide by the same rules as promotional 0 percent APR offers.

New Restrictions on Credit Card Fees
The Credit CARD Act also restricted the fees card issuers can charge on cards for people with bad credit to 25 percent of the card’s total credit limit in any given year.

But some card issuers got around this rule by inventing new fees, such as application fees and processing fees, that were charged before the credit card account was opened. Card issuers also charged monthly maintenance fees or credit limit increase fees that didn’t count toward the 25 percent limit.

However, the Fed caught on, essentially saying: If it looks like a duck, walks like a duck and quacks like a duck, it’s a duck. Going forward, card issuers have to include all fees charged to consumers when calculating the 25 percent total, irrespective of when the fees were charged.

Ability to Pay Now Based on Individual Income
The most controversial of the new Fed rules concerns how card issuers are required to evaluate the income of credit cards applicants. Card issuers are required by the CARD Act to take into account consumers’ ability to pay off credit card balances before the consumer is approved for a credit card. The purpose of the rule is to protect consumers from being given large credit lines that they can’t afford to pay off.

However, the CARD Act did not specify how card issuers should verify applicants’ ability to pay, so the industry standard has been to ask for total household income. But with the new Fed rules, card issuers must now consider the applicant’s individual income instead.

Critics of the new rule say that this requirement is bad news for stay-at-home moms or dads with no significant income of their own. Going forward, they will find it hard to get approved for a credit card, which could ultimately hurt their credit score.

Managing credit cards is an important part of building a credit history and developing a good score. Spouses who never establish an independent credit record will be seriously handicapped in today’s economy, say critics, especially if they later want to strike out on their own.

“Women trapped in abusive marriages may be unable to work due to a controlling spouse, a hallmark of relationships characterized by domestic violence,” argued Rep. Carolyn Maloney and Rep. Louise Slaughter in a letter to the Federal Reserve. “The availability of an independent credit card may represent her best chance at establishing independence and a path out of a dangerous relationship.”

The Federal Reserve counters that nonworking spouses can circumvent the issue by opening joint accounts with their spouses. This will give them similar credit-building benefits as having their own credit card.

But critics say that could also open another can of worms. For example, each spouse will be impacted by the credit habits of the other spouse — for better or worse. And should the couple later get divorced, one spouse could end up being on the hook for credit card debt incurred by their partner.

Still, the Federal Reserve Board defended its decision, arguing that the new rule focused on what the Fed considers to be the key directive of the CARD Act: Protecting consumers from incurring unaffordable levels of credit card debt.