Banks Start Tapping Their Best Clients

Back before the implosion of subprime mortgages poked a hole in the real estate bubble, credit card holders with impeccable accounts and high credit scores either cruised along with fixed rates on balances or no interest charges at all if they paid off their balances monthly. That is all about to change due to the unintended consequences Credit Card Accountability, Responsibility and Disclosure Act, which was signed into law by President Obama in May. The intended purpose of the law is to curb excessive, undisclosed, and arbitrary hikes in fees, penalties, and interest rates charged by credit card issuers.

Prior to the meltdown of banks’ balance sheets due to the mortgage crisis, many of those rate and fee increases were directed toward clients with repeated infractions and high risk profiles. The seeds of change were being planted then as banks with mortgage exposure started raising rates on their variable rate clients, even those with sterling track records. Despite the rate increases in the variable accounts, the clients with fixed rates continued to ride along undisturbed while “pay the balance in full” crowd rode an even smoother path of zero interest and negligible fees.

The new law, intended to save card holders’ money, is having the exact opposite effect as banks raise fees and rates ahead of the implementation of the law’s restrictions. Some of the biggest changes will hit the issuers’ best borrowers the hardest. The first of those changes has banks quietly changing the terms of millions of credit card accounts in reaction to tough new restrictions that will limit rate hikes. Because the new law does not restrict rate hikes on cards with variable rates, millions of card holders are being notified that their fixed interest rates no longer exist and that they are now variable account clients. The first two banks to notify their holders of the change in terms are Chase and Bank of America.

Bank of America is trying to cushion the shock for some clients by starting the variable rates at the same level as their previous fixed rates. Most of the variable rates have a formula based on the prime rate plus a percentage. For B of A, the variable rate is calculated at prime plus 6.65%, meaning that with the prime rate at 3.25%, variables will start at 9.9%. It’s all good except for the fact that with the Fed Funds rate at .25% and the prime rate at 3.25%, rates are at their lowest level in history and essentially have nowhere to go but up. Less than two years ago the Fed Funds rate was targeted at 5.25% and prime rates ran at 8.25%, meaning that with B of A’s current variable formula credit card rates would be ticking along at around 15%. Under the same scenario, another aspect of the new variable formula would set cash advance rates at around 30%.

Another motivation for banks to change their fixed rate accounts to variables is that the new law also prohibits banks from raising rates on existing balances at the time the law goes into effect. For variable rate accounts the law doesn’t apply.

The “pay the balance in full” crowd is in for a surprise as well due to the elimination of grace periods for interest. It’s now very likely that banks will begin charging interest from the time of purchase as opposed to the current policy of charging interest only on balances carried over to the next month.

Both Chase and B of A are blaming market conditions and the new regulations for forcing them into the actions they are now taking. Their main theme is that without the ability to mitigate risk via interest and fee hikes on their riskiest borrowers they are being forced to raise fees and rates on all their clients, in effect, forcing their best customers to foot the bill for the ones that are constantly in trouble. How high and how quickly those increased charges would be without implementation of the Credit Card Accountability, Responsibility and Disclosure Act is unknown but it’s a given that fees and rates were going higher over time under any conditions. What is becoming clear is that the new law is going to make things more expensive instead of less so over the short term and may not make that much of a difference to card holders over the long haul.