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If it has ever happened to you, then you know it stings – the big hike of the annual percentage rate (APR) on your credit card. If not, you may be wondering what the penalty APR definition is, it is when your credit card issuer applies what is called the penalty or default interest rate as a consequence for missing the payment deadline by more than 60 days. For many credit cardholders, that can mean a doubling of their interest costs. The national average APR is 15.8% and the typical penalty rate is upwards of 29% or more. Ouch! Fortunately, it’s not permanent, but the more you know about the penalty APR on a credit card, the sooner you can act to reduce your credit card interest rate.
What is a Penalty APR?
As the name implies, credit card issuers are quick to penalize cardholders when they are late in making a minimum payment. By law, they have to wait until a payment is late by at least 60 days, at which point they can ratchet up the APR to the stated penalty rate. The higher rate is effective on the existing card balance and future balances for up to six months, after which the issuer must review the account activity. If, after six months, the cardholder payments have been on time, the card issuer is required to lower the rate to its original level.
The penalty APR is used by credit card issuers to encourage cardholders to stay on top of their payments. All that is required to avoid the penalty is to make the minimum payment within 60 days of the due date. While it may seem overly punitive, issuers justify the rate increase based on the increased default risk they face when cardholders are more than 60 days late on their payments. However, such a steep rate increase can make it more difficult for borrowers to make their monthly payment in the future, which makes it seem counterproductive for the issuer.
Penalties Limited by Law
As a result of the banking crisis in 2008, politicians and government officials took a close look at the penalty APR and its impact on the ability of consumers to get out of debt. Consumers who were most likely to receive a penalty APR were already in a dire debt situation. With more of their monthly payment going to interest instead of principal, many consumers just fell deeper into a debt spiral.
In 2009, the Credit Card Accountability Responsibility and Disclosure (CARD) Act was passed to address many practices that were considered too punitive or unfair, including penalty APRs. As part of the act, Congress included the six-month review on accounts under penalty, which provides consumers with an automatic way out if they get back on track with their payments. It also set guidelines for how much and how quickly issuers can raise the APR within the first 12 months of a new account.
How to Avoid a Penalty APR
There is probably not much you can do to get out from under a penalty APR once you miss your payment by 60 days. But, there are a number of ways you can avoid the penalty box in the future.
Look for a Credit Card With No Penalty APR
Yes, there are card issuers who don’t charge a penalty APR on late payments. Chase, Citi and Discover all offer credit cards with no penalty APR. You can expect their credit qualifications to be pretty strict if they are willing to assume the greater risk of default.
Communicate With the Card Issuer
Sometimes all it takes to stay out of trouble is open communication. You should always try to get your credit card issuer to clearly define their penalty APR process. If you are on your way to a missed payment, contact your card issuer to let them know. They may be willing to reschedule your payment or skip it altogether.
If missing a payment is completely unavoidable you could also try to negotiate for a more reasonable penalty APR. There is no guarantee your issuer will help you out, but it doesn’t hurt to try. If you are a long-term cardholder in good standing, there is a good chance they will work with you.
Set Up Auto Pay
Missed payments often result from forgetfulness or preoccupation, but they can be avoided if you set up your account to have the minimum payment automatically debited from your checking account. If you do this, make sure to set the payment date for right after your pay day to ensure there will be money in your account.
Read Your Credit Card Agreement
Most cardholders don’t read their credit card agreements. Granted, it’s not the most exciting piece of writing. However, if people knew about the things that could trigger penalties and other fees, they might avoid them in the first place. Next time someone asks what is a penalty APR, you can help them better understand.
Author: Jeff Gitlen
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