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The penalty or default APR (annual percentage rate) is an interest rate that can be charged by credit card companies when a borrower fails to remain current on payments. Though this rate, as of recent changes in the law, cannot exceed 35% APR, this still represents a huge increase on what most people pay in credit card interest. Moreover, once a person has had a card fall into the default APR, it can be difficult to change the rate back, unless payment habits improve. Some regions allow people to cancel their cards upon notification of a default rate, but this isn’t always the case.
Up until 2010, credit card companies in the US were able to take advantage of a special loophole in the law called the universal default clause. Under this law, if a consumer didn’t pay the minimum payment on one credit card, all of his or her credit card lenders could respond by charging the default APR, even if they had no connection whatsoever to the company with which the consumer had defaulted. This practice was especially prevalent in the second half of the first decade of the 2000s, and many people found themselves with several credit cards that had extremely high interest amounts. In some cases, it became impossible to not default on most cards, because minimum payments climbed with higher interest rates.
In most regions, other credit card companies can no longer switch to the default APR unless a person specifically defaults on an arranged loan agreement with that company. For consumer lenders, default is often defined as being 60 days late on a payment, though more stringent definitions existed in the past and may still apply in some regions. Also, the new interest rate charged can only apply to new purchases, and most consumers are able to get out of the default rate if they make six consecutive months of on-time payments.
Still, it is very important for people to try to avoid any scenario where a credit card lender can charge this rate. Avoidance, from one perspective, is simple. People need to pay their minimum credit payment on time, not even a day late, or they risk an increase of interest rate to slightly over 23% plus the prime rate, not to exceed 35%. It’s possible that negotiation with a lender about missing a payment might also be enough to avoid the rate, but this can’t always be counted upon.
Default APR rules are different and more stringent for business lenders. The penalty APR may apply to the whole balance. There may additionally be more circumstances under which default occurs easily.
If consumer or business lenders are concerned about missing minimum payments, they should keep balances low, so payments are correspondingly low. It’s not a bad idea to set aside one to two months of minimum payments to the maximum amount that could be owed on the credit card. This could help avoid missing a payment and the default APR.