Credit Card Changes Begin, Market Changing Too

Some of the changes required of credit card companies through last spring's credit card legislation begin to take effect this week. Those changes force companies to give customers longer notice when changing the interest rate and to provide more time to pay their bill after it's mailed. A new credit card market is beginning to take shape, based on companies' reactions to the new regulation. The outcome will likely be something Congress didn't expect.

Here's some detail about the legislative changes, from the Washington Post.

Starting Thursday, issuers must give customers 45 days' notice before raising their interest rates, instead of 15 days as previously required. Customers can then choose to pay what they owe at the original rate over time but will not be able to use the card for future purchases.

The issuer reserves the right to increase the minimum payment, as a percentage of the total balance, to no more than double the percentage it had been. Card issuers will also have to mail bills 21 days -- instead of 14 days -- before the due date.

Of course, this is really a drop in the bucket compared to what's to come:

The law will eventually prevent card companies from raising interest rates on existing balances unless the cardholder is at least 60 days late making a payment. If the cardholder pays on time for the next six months, the old rate must be restored.

Companies are responding as you might expect: with a preemptive strike. They've been raising rates on their customers. They're also shifting many cards to a variable rate.

I am pretty confident that the majority of the letters people are receiving explaining such changes are related to the new credit card legislation. But the Post quotes a banking lobbyist who refutes that the new regulation is causing all of these changes:

"The assertion that it's being done in advance of the February implementation is a red herring," said Scott Talbott, senior vice president of government affairs for the Financial Services Roundtable. "Interest rates are going up because credit scores are going down. Your credit terms are based on your individual credit profile."

While I am sure that lower credit scores are contributing to increased rates, I think it's ridiculous to claim that the all, or even most, of the changes people are seeing are solely caused by the decline in credit quality. Numerous anecdotal examples make this clear. The one I'm about to explain does so, but also sheds some light on how companies' behavior might change the credit card market.

I was speaking with someone last night who told me a story about her recent dealings with a credit card company. She received a letter related to a credit card associated with a major department store. It explained that her interest rate would be increased to just over 20 percent plus the prime rate for purchases. The rate increased and went variable.

This woman has pristine, perfect credit. Her house is paid off. Yet, even she was susceptible to the changes. As it turns out, she had already canceled this card, because she didn't need it anyway. But after receiving the letter she called the company to make sure that the cancellation had gone in to effect. It had, and the representative she talked to told her that the changes were in response to Congress' legislation. He also said that a lot of people were cancelling their cards after getting the notices. But he said the company wasn't worried: for every cancellation there were two new customers.

This might seen counterintuitive, but given the broader economic picture, it shouldn't. Distressed Americans need credit cards now more than ever. If you've lost your job or have been forced to cut back hours at work, then you are probably coming up short every month. If you remain unemployed for an extended period of time, it won't take long to burn though a small amount of savings. When unemployment benefits run out, you'll really be in trouble. Credit cards might be these individuals' only alternative to keep up with even basic expenses once they've fallen behind.

So what I expect we'll see is many prime borrowers cancelling credit cards and potentially less prime and more distressed borrowers increasing balances and replacing those prime cancellations with new accounts. Obviously, many prime credit card customers will remain, especially if they're convenience users who pay their balance each month. But for those with prime credit who have extra cards, many will likely cut them up.

That should reshape credit card company portfolios through a downward shift in credit quality. But that's okay with them -- they make a lot more money off people with mediocre credit than with great credit. Besides, they already increased rates on all of their customers. As a result, they're more than happy to collect higher interest on higher balances and more fees on less prime borrowers.

If anyone is worse off due to the new credit card legislation, it appears to be non-prime borrowers. It's the distressed Americans who will be forced to pay higher rates and fees. Prime borrowers will be largely unaffected, since they rarely pay interest or fees on credit cards anyway.