Double Whammy
For People Buried in Debt,
Credit-Card Companies Pile On the Fees

By Mitchell Pacelle
Staff Reporter of The Wall Street Journal

When Jennifer Reid opened her credit-card bill in April, she discovered how expensive it was to make full use of her credit.

The 42-year-old X-ray tech had run through $10,000 of her $12,000 credit line on a card issued by MBNA. In April, her annual interest rate jumped to 24.98%, from 19.98% in March and far above the initial single-digit rate.

"I don't understand," she recalls telling an MBNA customer-service representative on the phone, complaining that she hadn't been late with a single payment. The representative agreed but pointed out that she had run up more than $5,000 of debt on two other cards. Also, she was making only slightly more than the minimum suggested monthly payments on her MBNA card. He said the company now saw her as a credit risk and feared it would take her forever to pay off her debts. "Isn't that what you want consumers to do?" she snapped back.

Fees Pile Up

That's a question more financially strapped bank customers are asking these days. For consumers who pay off their credit-card balances each month, shop aggressively for low interest rates and take advantage of generous credit-card rewards programs, consumer credit has never been cheaper. But for others like Ms. Reid, who went into debt so she could move to a better job in Florida from South Carolina, the trend is in the other direction. Card users, consumer advocates and some industry experts complain that banks are attempting to squeeze more and more revenue from consumers struggling to make ends meet. Instead of cutting these people off as bad credit risks, banks are letting them spend-and then hitting them with larger penalties for running up their credit, going over their credit limits, paying late and getting cash advances from their credit cards.

"People think they are being swindled," says industry consultant Duncan MacDonald, formerly a lawyer for the credit-card division of Citigroup. Penalty fees aren't new, but they are becoming more important to the industry's bottom line and are being borne by the people who can least afford to pay them, he contends. In 2003, the credit-card industry reaped $11.7 billion from penalty fees, up 9% from $10.7 billion a year earlier, according to Robert Hammer, an industry consultant.

Banks say that penalties and fees are a necessary component of new models for pricing financial services. They say they must rely on risk-based pricing models under which customers with the shakiest finances pay higher rates and more fees.

An MBNA spokesman notes that one of the most important considerations in setting a credit card's interest rate is "how a customer manages his account." If a customer's financial circumstances change for the worse, he says, the bank has to raise the rate "as a way of balancing that greater risk."

Such variable pricing has been embraced in recent years by airlines, mortgage lenders and others. What upsets bank customers, however, is that many don't discover the rate changes and penalty fees until they have already been hit with them. Those who complain are referred to disclosure statements that most consumers never read.

Until the early '90s, most banks offered one credit-card product. It typically carried an annual interest rate of about 18%and an annual fee of $25. Those who paid late or exceeded their credit limit faced small fees. Profits from good customers covered losses from those who defaulted.

Then card issuers, in an effort to grab market share, began scrapping annual fees and vying to offer the lowest rates. They junked simple pricing models in favor of complex ones tailored to cardholders' risk and behavior. To sustain growth, they began offering more cards to consumers with spotty credit.

By the late 1990s, banks were attracting consumers with low introductory rates, then subjecting some of them to various "risk-related fees," such as late fees and over-limit fees. In a survey of 140 credit cards this year, the advocacy group Consumer Action said 85% of the banks make it a practice to raise interest rates for customers who pay late-often after a single late payment. Nearly half raise rates if they find out that a customer is in arrears with another creditor.

Since the banks disclose the fees in the fine print of their mailings, they have had little to fear from regulators and the courts. The 1968federal Truth in Lending Act was enacted to promote "awareness of credit costs on the part of consumers." It required "meaningful disclosure of credit terms" but didn't say anything specifically about credit-card fees. The Federal Reserve's Regulation Z requires credit-card issuers to disclose the cost of credit as a dollar amount, known as the "finance charge," and as an annual percentage rate. Fees for late payments and the like were not to be included in either calculation.

Regulation Z

As a college student in the mid-1990s, Sharon R. Pfennig signed up for a card with a $2,000 credit limit. In 1997, buying clothing at a mall, she blew past her credit limit by $192. The card issuer, Household International, began tacking on a $20 over-limit fee each month. Ms. Pfennig stopped using the card and continued to make her $45 minimum monthly payments. But the monthly penalty fee, coupled with the $35 to $40 she paid each month as interest on her debt, caused her balance to continue climbing. Her monthly over-limit fee then jumped to $29, and her fee total eventually ballooned to about $700.

In 1999, Ms. Pfennig filed a lawsuit in Ohio federal court against Household and MBNA, which had purchased her Household account. The lawsuit accused Household of misrepresenting the true cost of credit by not including over-limit fees in its disclosed "finance charges" on her monthly statement. The suit said this practice, which adhered to Regulation Z, nonetheless violated the Truth in Lending Act.

An appeals court agreed with Ms. Pfennig but the Supreme Court sided with the bank. It said Regulation Z is reasonable and companies that follow it are in compliance with the law.

For now, the only way for consumers to know what they're getting into is to plow through the disclosure materials they receive when they open bank accounts or get new credit cards. Ms. Reid, the Florida cardholder, says she is far more careful now about studying her credit-card mail. "I read every single solitary word now. I hope one of these days I won't have to have a credit card at all."