How Cards Got Slippery

For years, state usury laws determined the maximum credit card interest rate their residents could be charged, usually a maximum of 10 to 20 percent. In 1978, however, the Supreme Court gave national banks the right to preempt the usury law of the borrower’s home state. When inflation sent interest rates up to 20 percent, banks in states with low usury limits saw their card operations lose money by the carload. Citibank, searching for relief, moved its card division to South Dakota and persuaded legislators there to repeal its usury law. In short order, Utah and Delaware dropped their interest-rate limits, too. After that, national banks with operations in those states could solicit customers anywhere and charge whatever rate they wished. State-chartered banks soon became exempt from state limits as well.

Since then, some banks have seduced customers with bait-and-switch introductory offers, like a 0 percent rate that rises by about 10 points a few months later. Issuers have changed customers’ rates with as little as 14 days’ notice and applied the new rate to old balances. So a refrigerator you charged at 9.9 percent could wind up costing 15.6 percent. For the cardholder who paid late two or three times (sometimes only once) banks invented the default or penalty rate, now as high as 32 percent, according to ConsumerAction, a nonpartisan advocacy group. A practice known as universal default allowed an issuer to slap on the default rate even if you had paid all of that issuer’s bills on time, if you happened to be late paying another company’s bill.

Adding to all the complexity, cards in the late 1990s started coming out with multiple rates — one for purchases, another for transferred balances, and a third for cash advances. In 1996, the Supreme Court held that fees for late payments, exceeding limits, cash advances, returned checks, and annual membership were a form of interest and also immune to state rate limits. Consumer advocates feared the decision would send fees skyrocketing. They were right. The effect of all these fees and penalty rates has sometimes been disastrous. A court found that one elderly Ohio woman living on Social Security paid Discover $3,400 on her original $1,900 credit-card debt and still owed the company $5,000 in penalty interest and fees.

How Consumers Are Protected

The chief source of credit card consumer protection is the Truth in Lending Act (TILA), which requires lenders to disclose terms so consumers can compare the cost of credit. Added protection came in 2000, when credit card companies were first required to include in every credit offer a “Schumer box” — a summary of a credit card’s cost — named for New York Senator Charles Schumer, who championed the legislation that led to the rules.

But simply giving credit card customers better fine print hasn’t been enough to keep many of them out of trouble. “It seems clear that improved disclosures alone cannot solve all of the problems consumers face in trying to manage their credit card accounts,” said Federal Reserve Board Chairman Ben Bernanke last December. After soliciting comment and receiving thousands of complaints from cardholders, the Fed issued a variety of consumer protection rules, which take effect in 2010. Among other things, they bar rate increases in the first year after a credit card account is opened. “The Federal Reserve’s rules are pretty strong, but they could go further,” says Joshua Frank, a senior researcher with the Center for Responsible Lending, a nonprofit advocacy group in Washington (see "Seven Credit Card Reforms Washington Needs to Make").