If you haven’t received a notice from your credit card company that your rates are increasing, well, you probably don’t have a credit card. What some people are missing among the fine print is that many cards are changing their rate structure from a fixed rate to a variable one. So, what’s the difference, why is this happening, and is this a big deal?
According to the OCC, a fixed-rate credit card means that the Annual Percentage Rate on the account “is not tied to an index that may change periodically.” Variable rates are generally tied to an index rate, such as the Prime Rate.
The OCC is quick to inform, though, that “for credit card accounts, the term ‘fixed rate’ does not mean that the rate cannot be changed over the life of the account.”
The change from fixed to variable is happening because when the new credit card law (i.e. CARD Act) goes into effect, credit card companies won’t be able to change rates on existing balances.
“Default rates are really high, more than double what than they had been,” said personal-finance columnist Liz Pulliam Weston. “Credit card issuers used to pick on the subprime folks and that’s changed this year. Now, they’re also terrified of people who carry balances, because they have so many defaults.”
So, because of the increasing default rates, issuers are scrambling for other ways to protect their revenues, particularly before the CARD Act goes into effect.
The credit card companies are changing to a variable rate because if they didn’t, any increase in the prime rate would eat away at their profit margins. Having been hammered by the skyrocketing default rate, credit issuers are looking to cover themselves in any way possible while they still can. Once the prime rates increase, banks could find themselves in a lending deficit.
Think about it: If you deposit $500, and your bank lends it to someone in the form of a credit-card loan, then what happens if they’re paying you 10% interest on your deposit and they’re only charging 7% interest on the credit card loan? True, these numbers are hardly based in reality, but you get the idea. Ultimately, they know that the CARD act will prohibit them from raising interest rates on existing balances.
“Most of the variable rates are being set to prime plus a percentage and unfortunately most people don’t realize what the changes in their credit cards will be when the prime rate starts going back up” said Lita Epstein, personal finance writer.
“Most people don’t realize what the changes in their credit cards will be when the prime rate starts going back up,” Epstein says.
The flip side of this statement is true, too.
“[Credit card companies] are so used to beating up subprime people who can’t fight back, they’re going to learn that people with good credit can take their business elsewhere,” said Weston. “They have not comported themselves with grace and dignity.”
It will be interesting to see whether the CARD Act marks the beginning of a more transparent and unassailable way of operation from the credit card issuers or they will still find ways to go back to their shady pre-CARD Act practices.
Disclosure: Some links point to CardHub.com, which is owned by the same parent company as this blog.