Read This: Why You Should Expect to Pay Higher Rates on Your Credit Cards

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photo credit: Fosforix

It’s no secret that credit card interest rates are on the rise. Even with mortgage rates at records lows, banks and credit card companies are increasing so-called ‘credit spreads’ to compensate for risk across their loan portfolios – and that means higher credit card annual percentage rates (APRs) for you and me.

With no end in sight, millions of Americans can expect to see the Annual Percentage Rates (APR) on their credit card statements steadily creeping upward. Many of us have already seen widespread increases in fees, reductions in credit limits, and increases in the minimum monthly payment amounts required by our card issuers. And for those in the market for a new credit card, you can expect the banks to impose significantly tightened approval criteria for all credit card offers across the board. It doesn’t matter who you are, credit has gotten scarcer and decidedly more expensive as the days of easy, cheap credit seem to be long behind us.

Banks of all sizes have tightened credit card lending and raised fees to compensate for risk. According to the Federal Reserve’s January 2009 Senior Loan Officer Opinion Survey on Bank Lending Practices report, “Large fractions of domestic banks continued to report a tightening of policies on both credit card and other consumer loans over the past three months.”

Of the banks surveyed, 58.8% tightened consumer credit card approval standards; 58% require higher credit scores; 46.9% reduced credit limits on existing credit card accounts; and most significantly, 40.7% of banks increased the ‘credit spreads’ they charge above their cost of funds on outstanding credit card balances. So for example, if a consumer pays an ongoing APR of 9.75% on a credit card balance but has good enough credit to only pay 9.00% on that balance, the yield spread on that particular loan balance is 0.75%. These credit spreads have been steadily and sharply increasing over the last year.

In addition to the wider credit spreads that consumers are being forced to pay, banks are actively increasing credit card APRs for three reasons:

1. To cover rising write downs and losses on defaults;
2. To cover “cash-trapping” losses; and
3. To compensate for losses in other areas.

Covering Portfolio Write Downs

It’s no mystery that banks are in deep trouble right now. The mortgage meltdown and credit portfolio losses have them scrambling for every nickel and dime they can find to counter balance the seismic loan losses.

Here’s a list of the 10 bank write downs from mortgage and credit-related losses during Q4 2007 and Q1 2008 according to Bloomberg:

1. Merrill Lynch – $24.5 billion;
2. Citi – $22.4 billion;
3. UBS – $18.1 billion;
4. HSBC – $17.2 billion;
5. Morgan Stanley – $9.4 billion;
6. IKB – $8.7 billion;
7. Bank of America – $7.9 billion;
8. Credit Agricole – $5.1 billion;
9. Credit Suisse – $4.8 billion;
10. Wachovia – $4.7 billion.

There are 25 banks on the list bringing total losses to well over the $100 billion dollar mark. On top of that, the 10 banks outlined above lost an additional $98.3 billion in write downs and credit losses in just the past six months!

Covering “Cash-Trapping” Losses

To make matters worse, “credit-trapping” clauses in securitization agreements are hurting banks even more. Just as with the now defunct subprime mortgage market, banks package and sell credit card debt portfolios to investors who share in the upside – yet are somewhat protected from risk through cash-trap clauses. “Securitization is an important economic tool,” says Rep. Carolyn Maloney, D-N.Y. “But when we saw the subprime (mortgage) meltdown occur, we started really looking at credit cards as the next crisis.” according to a recent USA Today article.

In good times, credit-card-backed securities provide investors with high-yield, relatively safe, investment returns. Today, however, “growing numbers of cash-strapped and jobless borrowers are finding it increasingly difficult to make their monthly payments. These delinquencies are finding their way into securities made up of pools of credit-card loans. As losses rise, they trigger a so-called cash-trapping clause, little known outside the debt market.” (MarketWatch). These so-called cash-trapping clauses reduce the spread banks make on credit card balances. Normally, the bank or card issuer receives a percentage of the return earned by investors on credit card-backed securitizations. But when yields drop below a certain threshold, a clause in the securities agreement protects the investor by blocking or “trapping” the proceeds from flowing back to the banks. So with increased credit card defaults, the losses being felt by the banks are magnified even more.

Recouping While They Still Can

To make up for those losses and to compensate for losses in other areas the banks have been steadily increasing rates and fees across the board, nearly everywhere they can. While Congress has stepped in with proposed legislation to help consumers with these egregious interest rate hikes, the credit card legislation designed to protect consumers will not take effect until July 2010. This gives banks a window of opportunity to ‘get it while they can’. So whether or not you have good credit or bad, most people should expect rates and fees to rise.

The new rules, issued by the Federal Reserve in December 2008, regulate banks to prevent unfair and deceptive credit card practices. The new regulations include:

1. Banning banks from raising interest rates on existing balances unless payment is more than a month late.
2. Prohibits the practice known as “double-cycle billing” in which a bank assesses interest on the entire amount charged during a 2-cycle monthly billing period unless the bill was paid in full.
3. Banning the practice of “universal default” in which customers are charged a higher interest rate if they miss a payment with another creditor or if their credit score has dropped even minutely.

Before these new rules will take effect in July 2010, there is very little to stop credit card companies from increasing the spreads they charge on credit card debt. In light of massive defaults on everything from mortgages and business loans to consumer credit cards, banks are increasing spreads on good accounts as a way to compensate for losses in other areas.

Credit card APRs are on the rise and there is very little that, we as consumers, can do about it. Even those with good credit missing even a single payment might see their rates soar. Automatic payments through your bank are just one way to mitigate the risk of late payments and lower the possibility of late payment.

For high credit score borrowers who never miss payments, rates are actually expected to decrease because the Prime Rate and other key indexes are at record lows. But for those of us who accidentally miss a payment or two through no fault of their own, banks are now hair-trigger quick to increase the credit spreads on borrowers missing payments, resulting in much higher APR’s than many of us have ever seen.

To keep the APR’s that you’re paying on your credit cards down or simply to avoid the prospect of having them shoot up quickly requires that make your card payments on time, no matter what.

Do whatever you have to do to ensure that you do or you’ll pay a hefty price.

This article was contributed by Steven Sildon who writes frequently about personal finance, debt consolidation and credit-related topics. Steve is a Senior Editor for CreditCardAssist.com where he provides credit card news, tips and advice on various credit card offers.