Laura Rowley Money & Happiness

A recent study finds that more credit card holders are being penalized by their card issuers as companies try to maximize profits and bring balance sheets in line ahead of a law banning unfair practices.

The ink is barely dry on the Credit Cardholders’ Bill of Rights Act, signed by President Obama in May, but the legislation doesn’t take effect until February 2010. According to the June survey of 1,000 consumers by Credit.com, a card-comparison and informational Web site, one-third of respondents said their card company made one or some combination of changes to their accounts:

* 19 percent said the card’s interest rose (up from 15 percent in a February survey);
* 14 percent said fees increased;
* 14 percent said the firm lowered their credit limit (up from 8 percent in February);
* 12 percent said their minimum payment increased;
* and 9 percent said their rewards program was cut back.
 
“It’s certainly open season on consumers between now and when the law goes into effect in February,” says Adam Levin, co-founder of credit.com and a former director of the New Jersey Department of Consumer Affairs. “There may be fee increases that are purely front-running of the law, and you could also have consumers who have run into problems because of the economy.”

Americans carry about $850 billion in credit card debt, which translates to about $17,000 for the roughly 50 million households that don’t pay their credit card balances in full every month, according to the Consumer Federation of America. Among other provisions, the new law prohibits retroactive interest rate increases on existing balances unless a consumer is 60 days late with a payment; bans “universal default” clauses, in which credit card companies raise their rates because the consumer is late paying another creditor; and eliminates over-limit fees, unless the consumer has specifically opted in to allow over-limit transactions.

The Dark Side of the Law

While it eliminates the most onerous practices, the law is expected to result in more annual fees, higher interest rates, and reductions in rewards programs -- especially for the most credit-worthy customers -- as companies try to offset the loss of their juiciest pockets of profit.

The new law “is not a silver bullet,” Levin says. “There will be an enormous amount of room for credit card firms to operate -- they can cut your limit or close your account at the drop of a hat.” If you rely on a single credit card, it may be worthwhile to open a backup account -- to avoid the risk of being shut out from credit altogether.

If you carry multiple cards, beware the unused piece of plastic. One of Levin’s employees, for example, had a credit score in excess of 815 (800 is considered excellent) and a card company reduced his credit limit by 60 percent. “Their argument was he wasn’t using his card enough,” says Levin. “If they give you a $25,000 credit line, they have to have a reserve against the $25,000. They are trying to limit their risk and exposure, and also see where they can rebalance the balance sheet. One way to do that is not carry enormous reserves -- and so they cut credit limits.” Levin suggests using 10 percent of your credit limit, always paying the bill in full at the end of the month.

Meanwhile, companies have shown no lack of creativity when it comes to fresh penalties, such as the “foreign transaction fees” slapped on transactions conducted in U.S. dollars but processed outside the U.S. Levin cites the example of a consumer who was hit with a 3 percent fee for purchasing tickets on a Malaysian airline. “The fee wasn’t an inconsequential number because it wasn’t a cheap ticket,” says Levin, adding that the tariff differed from the more common currency conversion fee because the payment was made in U.S. dollars.

Watch Out for Transfer Fees

If such practices prompt you to roll your balance over to a new card, watch out for balance transfer fees. Companies are charging transfer fees as high as 4 percent -- with no maximum limit. So if you roll over $10,000 in debt to a 0 percent card, you could pay $400 for the privilege.

Economic pressure and credit card shenanigans are prompting Americans to pay down debt at historic rates. Earlier this month the Federal Reserve reported that consumer credit fell by more than $15 billion in April -- the second-highest decline on record, and the seventh consecutive month that Americans paid off more than they borrowed. Revolving debt, which includes credit cards, tumbled by $8.6 billion, an annualized rate of 11 percent. The savings rate has soared to 5.7 percent, the highest in 14 years, according to the Commerce Department. (Some Americans are destroying cards in ritualistic ways and documenting their efforts on YouTube.)

Meanwhile, some consumers are negotiating outright settlements directly with credit card issuers, paying as little as 50 cents on the dollar. But Levin says there are potential pitfalls in the strategy. The credit card firm will report the charge-off to the credit bureaus, and a consumer’s credit score could fall anywhere between 50 and 200 points, according to Levin. “You have to look at it as a foreclosure on your credit report -- you can’t get much worse than that,” he says.

In addition, a settlement could trigger a significant tax bill. Any amount over $600 that is forgiven may be subject to income tax. “If you can prove to the Internal Revenue Service that you were technically insolvent at the time of the charge-off, there are cases where the IRS will waive the tax,” says Levin. “But the problem is when people do nothing, and the following January a 1099 shows up from the credit card firm. Then they try to reconstruct where they were financially at the moment of the settlement, and end up paying a tax they may not have had to pay.” The first call you make after you’ve cut a deal to settle credit card debt should be to a tax professional to discuss the tax ramifications.

As Americans work to shed debt, more people are favoring debit cards over credit cards. Banks are developing strategies to drive debit card use, including new reward programs, to boost the interchange revenue they collect from merchants. “It’s all about fee generation,” says Levin. With credit card fees on the downswing, says Levin, “the banks are saying, ‘what can we do now, how much can we make, and how fast can we make it?’”