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The Hidden Danger of Carrying Revolving Debt on Variable Rate Credit Cards
In 2009, Congress passed the CARD Act  with all intents and purposes of protecting consumers from unwarranted interest rate hikes, changes in terms to customer agreements, arbitrary fees levied by predatory lenders, etc. Beginning in 2009, credit card companies were in a “mad dash” to increase interest rates to shore up their balance sheets during the worst of the financial crisis while also ensuring existing accounts were more profitable in the future by increasing rates prior to the CARD Act’s regulations being fully implemented. Credit card accounts that were opened with agreements of 5% above the prime rate were adjusted to 15% above prime, rendering them consequentially more expensive and hurdling struggling consumers closer to the brink of personal insolvency, if not completely bankrupt. Minimum monthly payments doubled, and in some instances tripled, although consumers had not been late on a payment, had not gone over their limit, and there were no adverse accounts reporting to the three credit reporting agencies. All the while, consumer spending in the general economy slowed to a trickle as household budgets were squeezed by adjusting rates on their cards (and in many instances, their home mortgages) .
While there are several types of credit cards (prepaid, fixed, variable, annual fee, no annual fee, rewards, etc.), the most predominate card is a variable rate card. Although the “variable” in the “variable rate” card has lain dormant since December 2008  when the Wall Street Journal’s (“WSJ”) Prime Interest Rate hit its current floor of 3.25%, that rate can increase without notice and is NOT protected by the CARD Act. Using the rate from the example above of 15% over prime with prime equaling 3.25%, the total interest rate for that account is 18.25%.
15% (Base Rate)
+ 3.25% (Prime Rate Published by WSJ)
= 18.25% (Effective Rate)
Should the prime rate increase so will the effective interest rate on the variable rate card. For example, in December 1980 the prime rate was 21.5%. Should prime rate suddenly and swiftly rise, as in 1980, a variable rate card with a base rate of 15% could conceivable have an effective rate of 36.5%.
15% (Base Rate)
+ 21.5% (Prime Rate in 1980 as Published by WSJ)
= 36.5% (Effective Rate)
The prime rate is tied to short-term lending by the government to lending institutions. Currently, the federal interest rate extended to banks is 0% - 0.25% and is scheduled for another review on September 20, 2011. To arrive at the WSJ interest rate, lenders use the benchmark federal rate and add 3%. So as to be clear, the government loans the bank money at 0% to 0.25%, the bank loans consumers money at 0.25% plus a 3% benchmark to arrive at the WSJ prime rate, and then charge a base interest rate to arrive at a total effective rate:
0.25% (Federal Rate Extended to Banks)
+ 3% (Value Added to Arrive at WSJ Prime Rate)
= 3.25% (WSJ Prime Rate)
+ 15% (Base Rate)
= 18.25% (Effective Rate)
Although the chairman of the Federal Reserve, Ben Bernanke, has stated that the federal rate will remain near zero for “an extended period of time” and quantitative easing “will likely end in early 2012,” the current forecast bears a 1.25% increase in the federal rate by December 2012. A single percent may not sound like much, but to a consumer class already struggling with the previous lender increase, unstable prices at the gas pump, inflationary prices at the grocery store (all with stagnant wages since 2009), it is little wonder “consumer spending” in the economy is at a trickle.
While the prime rate has had a nearly 3-year extended run at 3.25%, it has undoubtedly lulled many consumers into believing that their rates are now fixed when in fact they are not. When the federal rate rises, as it surely will with the threat of further downgrade to the federal credit rating by Moody's, Standard & Poor's, and Fitch, the CARD Act will offer no protection to the consumer since that is not how the Act was designed. The only protection afforded the consumer is that their base rates above prime cannot be adjusted without 45 days notice to allow consumers the opportunity to pay off high interest, high risk variable rate cards.
Although this will undoubtedly create additional hardships for some, the lender will be unaffected in that their base rate provides their cushion so as to continue to eat at the wealth of consumers who choose to carry a balance.
For related topics, please see the author’s other HubPages articles.
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