Credit Card Reform: The End of Universal Default

by · 19 comments

photo credit to Ben Seidelman
This is a guest post from Kevin Bowen, a content writer for RESQdebt.com

There have been few more controversial credit card practices than the one known as Universal Default. With the arrival of the Credit Card Accountability, Responsibility, and Disclosure (CARD) Act of 2009, it is thankfully expected to become a thing of the past.

What is Universal Default?

From Wikipedia:

“Universal default is the term for a practice in the financial services industry for a particular lender to change the terms of a loan from the normal terms to the default terms (i.e. the terms and rates given to those who have missed payments on a loan) when that lender is informed that their customer has defaulted with another lender, even though the customer has not defaulted with the first lender.”

Why we SHOULD care about it…

The elimination of universal default is one of the most important provisions of the sweeping federal legislation, signed in May and going into effect in stages through next August, that is expected to change the face of the credit industry, probably including ways that we do not yet expect.

Universal default provisions, often buried in credit card contract gobbledygook, have allowed the credit card companies to charge cardholders more interest for late payments that had nothing to do with that specific account. Simply put, this common provision has allowed the credit card companies to increase the interest rate when a consumer fails to make a payment on another unrelated account, be it another credit card account or some other type of credit account. Like a phone bill. Or a water bill.

The CARD Act would limit increases in interest rates to “a specific, material violation of the card agreement by the issuer,” according to a Senate Committee report on the bill. It also requires credit issuers to lower penalty rates after six months if the cardholder meets his obligations.

The dollar amounts involved in Universal Default can be significant. The finance website The Motley Fool calculated that an $8,000 balance could see an increase of $1,200 per year with an interest rate rise of 15 to 30 percent. If you are on the border of being able or not being able to pay your credit card bills, the default provision can make the difference, particularly when compounded over several cards.

Advocates and Critics…

Advocates of the universal default provisions would say that they are accepting the reality of a consumer’s overall credit profile. If a person fails to make a payment on another account, it could indicate that they will have a more difficult time making a payment on the subject credit card account when the time comes. Therefore the increase in interest rates can discourage further borrowing that cannot be met with payment. In addition, it keeps more reliable cardholders from having to pick up as much of the tab if in fact that person eventually defaults on the balance.

Critics of Universal Default, however, point out that having multiple creditors simultaneously raising the interest rates and charging the consumer more can create a credit card death spiral that would not have existed without the universal default provisions. In addition, they have questioned the fairness of altering a contract when the contract has not been violated. It is perfectly reasonable to think that a person can miss a payment on one card for a variety of reasons and still make the regular payments on another.

How will credit cards fight back?

Is Universal Default really dead, or will credit card companies simply figure out alternative ways to accomplish the same goals of separating us from out money?  I suppose only time will tell.

What do you think?

I say we keep a keen eye on the whole situation!



Betterment is one of my two favorite ways to earn interest on my savings! They have an awesome program for the Average Joe to save and invest simply and effectively. There are no minimum balance requirements and no transaction fees. Read my Betterment Review or open an account to get started earning now.

1 Kevin@OutOfYourRut

I’d always known about this provision, but never knew it had a name (thanks!).

We have to hope that universal default will really be gone forever. The provision means that nothing like a contract exists between lender and borrower because terms can be altered by the lender–to the detriment of the borrower–for reasons outside the relationship between the two. The borrower can perform all obligations to the lender under the agreement, but the lender can still put the borrower in default status. That isn’t even a contract in the true sense.

We’ve been playing with fire with credit cards–all of the claimed advantages notwithstanding. It hasn’t been a relationship between two equals, and that alone makes credit cards something to be avoided.

In another example, the supposed Bankruptcy Reform Act of 2005 was a complete win for credit card issuers. There was no reform in that act that was in the borrowers favor. Everything in it keeps the borrower on the hook to the lender for more time and money. How does the economy recover if buried borrowers can’t get out from under?

If I have to bet, my position is that in some form, universal default will be retained, or replaced by an equally unfavorable provision. But let’s dare to hope not.

2 Matt Jabs

You’re probably right Kevin… that is why it is so great to remember that we have the choice to pay off the debts and terminate the toxic relationships.

We need to realize that we have the power, not the banks. It is them that want our money… and they can only have it if we give it to them! 🙂

3 Credit Card Chaser

All debt has a cost. This cost of debt is legally justifiable, morally justifiable, and economically justifiable. If one does not want to pay this cost of debt then they shouldn’t use debt (as I do because I just set my American Express card to automatically pay off the balance in full every month from my checking account). However, if someone wants to borrow money then of course it should cost something.

What is kind of funny is that many people whine about bank fees when even the Bank of America credit card division has lost money in the last 5 quarters in a row because so many people have defaulted: http://www.creditcardchaser.com/boas-credit-card-business-is-losing-money-yet-still-catching-flak/

Honestly though, even if they were posting record profits it wouldn’t matter to me in the least though because Matt is exactly right in that each and every one of us has a choice to use credit responsibly, irresponsibly, or not at all. Many people just don’t like to confront this issue because they like to think that credit should not have a cost to it and that they shouldn’t have to face the consequences of their actions.

The hard and fast black and white numbers of credit card interest rates are an inescapable consequence to being a bad credit risk that people have to face. Sure, we would all like free credit, ice cream sundaes for every meal, and money to fall out of the sky while we watch football on our recliner instead of go to work but that is not how the world works and I am glad for that.

Getting rid of the Universal Default provision is a bad thing because let’s face it – if someone defaults or pays late on one account they are more likely to default or pay late on another account – whether it will happen in this month or in a future month. That is fact. There is no arguing with that fact.

Once you admit that this is fact then it follows that getting rid of the Universal Default provision means that people who are BAD credit risks that would have had their rates raised in the past with a Universal Default provision will now not be able to be rightfully singled out by the credit card issuer and NOW everyone who has a credit card will have to bear the increased rates and fees to compensate – even those with GOOD credit. How is that fair?

All choices in life have consequences. Some people can avoid thinking about the consequences but they exist nonetheless. Of course, the government can step in and try to shield people from having to face the consequences of their bad choices but that short term shield will only last so long before the government regulations end up causing many other unintended negative consequences – one of which is the situation I just described above where everyone gets hit with higher rates and fees regardless of their individual credit risk.

4 BG

“Getting rid of the Universal Default provision is a bad thing because let’s face it – if someone defaults or pays late on one account they are more likely to default or pay late on another account – whether it will happen in this month or in a future month. That is fact. There is no arguing with that fact.”

No, Universal Default will increase the chance that you will default on other accounts. Being late on your water bill does not mean you are more likely to renege on your CC obligations. But having your CC interest shoot up to 30% because you were late on your water bill will increase the likelihood of reneging on the CC debt.

What you are arguing is like a waitress who thinks she will get a bad tip from a certain table, so she provides bad service, hence getting a bad tip — fulfilling her own prophesy.

In her mind, she correctly predicted the bad-tip, but doesn’t realize she “caused” the bad tip in the first place by her neglecting the table and providing bad service.

CC companies should provide value to their customers, by _lowering_ interest rates (temporarily) when their customers have financial hardships — hence increasing the likelihood of being paid back fully. Increasing interest rates just causes a death-spiral.

I’ve said before, and still believe, that the CC industry is the only industry that I know of, that strives to put their customers into bankruptcy.

5 Credit Card Chaser

“Getting rid of the Universal Default provision is a bad thing because let’s face it – if someone defaults or pays late on one account they are more likely to default or pay late on another account – whether it will happen in this month or in a future month. That is fact. There is no arguing with that fact.”

The above statement is still a fact. You are also correct when you say “Universal Default will increase the chance that you will default on other accounts.”

“CC companies should provide value to their customers, by _lowering_ interest rates (temporarily) when their customers have financial hardships — hence increasing the likelihood of being paid back fully.” There are actually different credit card “insurance” programs that say that if someone becomes disabled, loses their job, etc. then the credit card insurance kicks in and the consumer does not have to make a payment at all for X time period. I could see where this would maybe be a valuable thing for someone who carries a balance but this insurance costs money of course (as it should) and most do not purchase it.

That being said – outside of financial difficulties that are outside of ones control and not due to financial irresponsibility (financial irresponsibility is the cause of most payment difficulties) – then only in American would someone think that the credit card companies should give an IRRESPONSIBLE borrower who doesn’t pay on time a more favorable interest rate than a RESPONSIBLE borrower who pays on time.

6 Lydia aka Ms. MoneyChat

i say we remain credit card debt free so that we’re not a risk of whatever scheme or plot they come up with next. on the one handi applaud this legislative move but, on the other hand i believe the financial institutions will just find another way to skin the cow. this is a win, at least for now, for those who have been “victims” of this unfair practice.

7 Matt Jabs

“i say we remain credit card debt free so that we’re not a risk of whatever scheme or plot they come up with next.”

I agree! Hear!

8 BG

A neighbor of mine had a dispute on a “store” credit card and was working with their credit department to fix the error. In the meantime, automation kicked in and put a ding on his credit report, and within a month or so, all his other credit cards shot up to the default rate (due to universal default).

Universal Default is just like the mafia saying: “Shut-up and pay, if you know what is good for you.”

9 Matt Jabs

As far as I am concerned the credit card industry is just another form of organized crime… I think you hit the nail on the head BG.

10 Tina

Good to see this law going into effect. I agree Matt, the credit card industry IS just another form of organized crime!

11 KayRo

Now if we can just get the insurance companies to stop their own brand of “Universal Default.” My auto insurance went up significantly because of my sources of credit (and I have an EXCELLENT credit score). I was told that use of certain types of credit (for example, retail store accounts but it’s pretty much whatever they want to use to raise the rate) is “correlated” with higher payouts by the insurance company. So that justifies them raising the rate.

Anyone know anything about statistics? Correlation is easy — You can correlate anything with anything. For example, you could say having a pet is correlated with dying and you’d be right — people who have pets die. But that doesn’t mean the pet caused the death!

Cause and effect should be the basis for rate increases, but that would be so much less profitable.

12 BG

KayRo) I agree.

Correlation does not imply causation!

Butter production in Bangladesh has the has the highest correlation with the S&P 500. If you look at a database long enough, you can find all sorts of things correlated with each other — but that does not imply one causes the other (or vice versa).

Ice-cream consumption is correlated with murder rates too…

Anyhow, this is why I shop around for insurance everytime renewal comes along. I am never ‘loyal’ to an insurance company.

13 Credit Card Chaser

Yea, I think that the credit card companies should actually just let us borrow money for free without charging us any interest at all. In fact, I think that if we make a few late payments on our mortgage, water bill, and a few of our credit cards that the credit card company should just realize that maybe we had more important things to do with our time and money instead of being disciplined and responsible and actually paying our bills on time (or better yet – paying off our balance in full each month). After all, why should we be forced to have to have deal with the consequences of our bad choices? That is such an outdated concept. I like the idea of the government stepping in to control things like the Universal Default provisions so that it will be more difficult for the credit card companies to assess risk on individual consumers who are big credit risks and instead to just spread the fees and higher rates amongst all of us regardless of whether we are a good credit risk of a bad credit risk. After all, why should we be forced to have to have deal with the consequences of our bad choices? 🙂

14 BG

CC Chaser) It’s the changing of a contract, _after_the_fact_ that is the problem. If I’m late on my water bill, how exactly did I break my contract with the CC company that gives them the right to increase the interest charges on purchases I made a year ago? The dispute in question is between me and my water company. Perhaps the water company incorrectly billed me $10,000 instead of $100 (it’s happened to people before) — the CC company should mind their own business!

If the CC company deems someone no longer credit worthy, then they should close the CC account on the person (no new extension of credit), or increase interest charges on _future_ purchases. Changing the terms of a purchase, years after the fact, is the problem. I was “credit worthy” a year ago, but now, after making payments on-time to them, I should be “robbed” because of an issue with a third party company?

Also, you neglect to mention the fact that 25% of credit reports have serious mistakes in them, and 79% of all reports contain either serious errors or other mistakes of some kind. This is the data-set that CC companies are using to put someone into “Universal Default”.

http://www.uspirg.org/home/reports/report-archives/financial-privacy–security/financial-privacy–security/mistakes-do-happen-a-look-at-errors-in-consumer-credit-reports

15 Paula

Personally, I have mixed emotions about this provision.

One one hand, creditors make a lending decision based on the financial condition of the application. Therefore profit or loss on the account is based on the changing condition of the credit card holder’s finances. Furthermore, I don’t begrudge a business trying to make a reasonable profit. (“reasonable” is beyond the scope of my comment 😉 )

On the other hand, the manner in which many credit card issues make changes and deal with card holder is just plain deceptive. Time and time again I see firms attempting to bury customers with BS in an effort to obscure what they’re doing. This is fundamentally dishonest and should be stopped.

Regardless of what happens with Universal Default, I think that consumers should attempt to avoid the issue altogether by reducing both the number of credit cards used and the balances on those cards. As a result, Universal Default will be less impactful.

16 Credit Card Chaser

“It’s the changing of a contract, _after_the_fact_ that is the problem.”

Universal Default is not a breach of contract because if it is in the contract then it was either in the contract from the beginning or there was a provision to make it allowable in the contract. You better believe with all of the high priced attorneys working on forming credit card contracts that they will be legal. If someone doesn’t like a particular provision in the contract then they can always choose to use a different card or better yet just not carry a balance.

“If the CC company deems someone no longer credit worthy, then they should close the CC account on the person (no new extension of credit), or increase interest charges on _future_ purchases. Changing the terms of a purchase, years after the fact, is the problem. I was “credit worthy” a year ago, but now, after making payments on-time to them, I should be “robbed” because of an issue with a third party company?”

It’s not being “robbed” because it is part of the agreement that you signed with the credit card issuer as a condition of your line of credit. Those were the terms that they chose to extend to someone of your credit risk and as they have the money that you would like to use then its up to you to either take it or leave it.

“Also, you neglect to mention the fact that 25% of credit reports have serious mistakes in them, and 79% of all reports contain either serious errors or other mistakes of some kind. This is the data-set that CC companies are using to put someone into “Universal Default”.”

This is a great point actually and I agree with you that being proactive about these kinds of things is the answer. Work with the credit card company and the credit reporting agencies and then there won’t be an erroneous data feeding falsely into any of your lenders.

17 Kevin@OutOfYourRut

Credit card chaser–two things. First, you’re correct, there is no breach of contract because universal default is in the contract. However that means–in practical terms–it’s an unequal contract, and therefore one we should never enter into. The lender has all of the power.

Second–“Getting rid of the Universal Default provision is a bad thing because let’s face it – if someone defaults or pays late on one account they are more likely to default or pay late on another account – whether it will happen in this month or in a future month. That is fact. There is no arguing with that fact.”

This reads disturbingly like convicting someone of a crime without a trial. May be “legal”, but it isn’t right.

18 Credit Card Chaser

“Credit card chaser–two things. First, you’re correct, there is no breach of contract because universal default is in the contract. However that means–in practical terms–it’s an unequal contract, and therefore one we should never enter into. The lender has all of the power.”

I would say the same thing I have always said and that is to use credit cards strictly for rewards or cash back and just pay off the balance in full every month so that this is not an issue but either way it is very very very important to remember that the universal default provision only ever kicks in if someone is IRRESPONSIBLE and does not pay their bill on time (whether its a water bill, electric bill, or credit card bill) so even for those people who do not pay off their balances in full every month as long as those people actually follow through with their end of the various agreements they entered into and pay their bills on time then this is a non issue.

I do not mean to sound harsh but I am not opposed to companies imposing penalties on people that do not fulfill their end of the agreement and pay ALL of their bills on time in order to continue receiving the same lower interest rates as the rest of us who make payments on time. If credit card companies are not allowed to price this risk correctly then they will be forced to increase rates across the board – even for people who pay on time.

After all, when I was a student in college with little money I am glad that I got hit with some $39 overdraft fees on my checking account because it taught me the importance of managing my money properly. Of course, it wasn’t so fun at the time but looking back I am glad that I got to see immediate negative consequences to the poor financial decisions I made – now if only we got hit with $39 fines every time we skipped a workout or ate a whole pizza 🙂 (I am just trying to lighten the mood really because even that is a bad analogy because remember it is the consumers contractual responsibility to make payments on time for ALL of their bills)

19 Financial Samurai

I’ve gotta say, it’s interesting how credit cards is such a BIG topic among the PF community.

The interest in credit cards, as well as credit card focused sites leads me to believe in the widespread addiction with a tool that has caused countless financial pain, no?

Credit card marketing in college? Shame on them. I have two CC’s, and I use them to my advantage (free 30 day cash conversion cycle and rewards) and never the other way around. Why don’t others do the same??

Previous post:

Next post: