Universal Default and credit card reform

Will credit card reform end the universal default provisions, sparing customers a debt spiral?

There have been few more controversial credit card practices than the one known as Universal Default. With the arrival of the Credit Card Accountability, Responsibility, and Disclosure (CARD) Act of 2009, it is soon expected to be a thing of the past.

The elimination of universal default is one of the most important provisions of the sweeping federal legislation, signed in May and going into effect in stages through next August, that is expected to change the face of the credit industry, probably including ways that we do not yet expect.

Universal default provisions, often buried in credit card contract gobbledygook, have allowed the credit card companies to charge cardholders more interest for late payments that had nothing to do with that specific account. Simply put, this common provision has allowed the credit card companies to increase the interest rate when a consumer fails to make a payment on another unrelated account, be it another credit card account or some other type of credit account. Like a phone bill. Or a water bill.  

The CARD Act would limit increases in interest rates to “a specific, material violation of the card agreement by the issuer,” according to a Senate Committee report on the bill. It also requires credit issuers to lower penalty rates after six months if the cardholder meets his obligations.

The dollar amounts involved in Universal Default can be significant. The finance website The Motley Fool calculated that an $8,000 balance could see an increase of $1,200 per year with an interest rate rise of 15 to 30 percent. If you are on the border of being able or not being able to pay your credit card bills, the default provision can make the difference, particularly when compounded over several cards.

Advocates of the universal default provisions would say that they are accepting the reality of a consumer’s overall credit profile. If a person fails to make a payment on another account, it could indicate that they will have a more difficult time making a payment on the subject credit card account when the time comes. Therefore the increase in interest rates can discourage further borrowing that cannot be met with payment. In addition, it keeps more reliable cardholders from having to pick up as much of the tab if in fact that person eventually defaults on the balance.

Critics of Universal Default, however, point out that having multiple creditors simultaneously raising the interest rates and charging the consumer more can create a credit card death spiral that would not have existed without the universal default provisions. In addition, they have questioned the fairness of altering a contract when the contract has not been violated. It is perfectly reasonable to think that a person can miss a payment on one card for a variety of reasons and still make the regular payments on another.

Is Universal Default really dead, or will credit card companies figure out other ways ot accomplish the same goals? Only time will tell.   

Kevin Bowen is a writer for Resqdebt, a Dallas-based Financial Health Management company specializing in debt settlement services.