Tuesday, February 10, 2009

Universal Default -- What it is and How to Avoid it

Universal default is a relatively new provision that has been added to the credit card member terms and conditions by credit card companies. Universal default basically allows creditors to review a customer's credit report on a regular basis, and if there is any change that has negatively impacted their credit score a new, higher interest rate can be applied.

The customer behaviors that can potentially trigger universal default pricing by a credit card issuer include the following:

  • Being late (even once) on a credit card, mortgage, utility or car payment
  • Going over the credit limit on any credit card
  • Carrying too much debt overall
  • Using over 50% of the credit line for an individual credit card
  • Having too much available credit and open trade lines
  • Making too many credit inquiries
  • Getting a new mortgage or car loan

Universal default is not meant to hurt consumers. Rather, it is intended to protect credit card companies from potential losses by charging higher interest to those customers with degrading risk profiles. It is somewhat analogous to a health insurance company charging higher insurance premiums to someone who smokes, even though they haven't filed a claim.

The best way to deal with this new provision is to simply not have it apply to you. The best rule of thumb is to always, always pay your bills on time. That includes your utility and magazine subscription bills. Almost any company that bills for services can report your payment behavior to credit bureaus, who in turn sell this information to lenders. Even if you haven't become a true credit risk, irresponsible behavior can create the perception of increased risk propensity.

Probably the safest course to take is to stay out of debt. By employing fiscal discipline, you can simply not care about silly things like interest rates. If you are not able to do this because of outstanding balances that are priced at high APRs, you may want to consider a balance transfer to a 0% APR credit card. That way, you can start aggressively paying down the balance and become debt free much faster, without having interest charges drag down your finances.

Approximately 45% of credit card issuers have universal default provisions contained within their cardmember agreements. It is important for consumers to understand these types of potential costs by reviewing the terms and conditions beyond the introductory APR prior to applying for a card. And while these policies probably won't go away, it's important to realize that banks are just businesses that are taking steps to protect their bottom line and shareholders. Rather than having these types of charges apply to you, simply exercise a little caution and discipline to enjoy the benefits of credit cards without the pitfalls.

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