Last Updated: June 1, 2009
As a bill of rights go, this one is fairly important. Especially if you use credit cards and happen to carry a balance over from month to month. On May 22, President Barack Obama signed into law the Credit Cardholders Bill of Rights.
In general, the new law prohibits credit card companies from arbitrarily raising the interest rate on your credit cards and charging certain fees, among other provisions. Not surprisingly, consumer advocacy groups and financial planners had mixed reactions to the new law, with some suggesting that certain provisions would curtail consumer credit and others suggesting otherwise.
"My initial reaction was concern," said FPA member Kim Nourie, CFP®, CPA, of Cross Financial Services. "While reform of some sort is needed, it appears that a number of consumers may be negatively impacted by the new legislation."
Others, however, had a different point of view. "Americans will likely benefit from the increased transparency that this bill requires," said FPA member Diana G. Simpson, CFP®, of Fee-Only Financial Planning Professionals.
The Law at a Glance
Under the new law, credit card companies:
- Cannot increase interest rates arbitrarily. Rate increases are allowed only if you pay your bill more than 60 days late, if a promotional rate expires, if the rate is variable, or if you don't comply with a payment agreement.
- Must give at least 45 days notice before increasing interest rates or changing fees.
- Cannot use tiny print in their disclosures. They must use 12-point font.
- Must apply payments to the debt with the highest interest rate first.
- Must mail bills to you 21 days before the due date and must also accept payments as on time if the due date falls on a Sunday or holiday and the payment is received the following day.
- Can no longer charge interest on portions of balances that were already paid on time.
From her perspective, Nourie said the new law could result in the following: "1) in general consumers with better credit and risk profiles will not receive offers as favorable of terms as in the past, and 2) there will be banks that target niche markets or possibly offer different types of cards — one niche being the lowest risk consumer. More conservative banks may opt for this cardholder and offer favorable rates. Other banks may opt for higher risk consumers and offer higher interest rates to their cardholders to offset the risk."
The bottom line she said is this: "I think we will have higher risk consumers paying exorbitant interest rates on credit cards — where does the legislation limit the rate of interest that can be charged? I think the banks will be looking at ways to continue making the same level of profit they currently make. Who likes being told that they are making too much money?"
That's not to say that the new law doesn't have its benefits, said Nourie. "The change for the better is that consumers will hopefully understand the terms of the credit from the get-go as opposed to having ever changing terms and conditions. And, it's good to have standard billing cycles."
Plus, Nourie noted it's a big benefit to have payments applied first to higher interest debt instead of lower interest debt. "Doesn't it make sense that as you pay down your debt you become less of a risk to the bank?" she asked. "Also, being able to pay down higher interest tranches first will help those consumers who are making minimum payments."
In the short-term, until the new law and its provisions are fully understood and incorporated into the warp and woof of America, Nourie thinks that "all of us may be paying more for credit until everything flushes out. The downside is we have all of this change going on while the economy is trying to recover from a deep recession."
That downside aside, however, Nourie is hopeful that the new law will serve over the long-term as a reminder that our culture needs to continue the process of deleveraging and stop living on credit.
For her part, Simpson said, "This bill takes away the credit card company's ability to raise a customer's fees without clear explanation and disclosure, and this is a good thing. But there has always been, and will continue to be, a class of customers who are either ignorant of, or oblivious to, fees — and this bill will not help these people."
So what should you do in light of the new credit card bill of rights? In some ways, that depends on how you use your credit cards.
Build an Emergency Fund
"Americans who use credit cards to pay unexpected expenses or for other emergencies will also not be affected by these changes, except to the extent that they are able to access credit, because they too will use the cards no matter what the cost," said Simpson. "To this group I would say that establishing a cash reserve fund and/or emergency fund — the foundation of any financial plan — would reduce their dependency on the cards and provide greater financial security."
Creating an emergency fund can be difficult. However, Simpson said saving even $100 per month into a savings account can make an enormous difference. "The good news is, once the emergency fund is established, it's there — you don't need to build it up further until you have to use some of it."
Pay Down Debt and Save at the Same Time
Americans who use credit cards to maintain a lifestyle that they would otherwise not be able to afford should pay close attention to the changes being made within the credit card industry, said Simpson. "Perhaps the days of reckless spending are over?" she asked. "For these consumers, paying off debt while establishing some savings is in order. Although most people think it is best to pay down debt and then build up savings, this is not the case. It is best to do both concurrently. Rather than pay the extra $200 towards the credit card, one should put $100 in the savings account and $100 toward the card. When an emergency or 'spending opportunity' arises, use the cash in the savings account. The goal is to get out of the habit of using the credit card and to feel the pain of using real money. I find that people tend to spend less — a lot less — when they are spending cash!"
Examine Your Spending
In addition, "closely monitoring and changing their spending habits would be the next strategy," said Simpson. "Americans dislike being limited to a budget," she said. "But it is a fact that those who live within their means are able to get ahead financially. Perhaps the next cultural change in this country will be away from materialism and towards living responsibly."
Nourie agreed. "I am hopeful that the new law will serve over the long-term as a reminder that our culture needs to continue the process of deleveraging and stop living on credit," she said.
If you need help understanding the new credit card bill of rights, you may want to work with a financial planner. Find a financial planner at FPA PlannerSearch®.