Increased Complexity in Rates and Fees Heightens Need for More Effective Disclosures to Consumers
GAO-06-929: Published: Sep 12, 2006. Publicly Released: Oct 11, 2006.
With credit card penalty rates and fees now common, the Federal Reserve has begun efforts to revise disclosures to better inform consumers of these costs. Questions have also been raised about the relationship among penalty charges, consumer bankruptcies, and issuer profits. GAO examined (1) how card fees and other practices have evolved and how cardholders have been affected, (2) how effectively these pricing practices are disclosed to cardholders, (3) the extent to which penalty charges contribute to cardholder bankruptcies, and (4) card issuers' revenues and profitability. Among other things, GAO analyzed disclosures from popular cards; obtained data on rates and fees paid on cardholder accounts from 6 large issuers; employed a usability consultant to analyze and test disclosures; interviewed a sample of consumers selected to represent a range of education and income levels; and analyzed academic and regulatory studies on bankruptcy and card issuer revenues.
Originally having fixed interest rates around 20 percent and few fees, popular credit cards now feature a variety of interest rates and other fees, including penalties for making late payments that have increased to as high as $39 per occurrence and interest rates of over 30 percent for cardholders who pay late or exceed a credit limit. Issuers explained that these practices represent risk-based pricing that allows them to offer cards with lower costs to less risky cardholders while providing cards to riskier consumers who might otherwise be unable to obtain such credit. Although costs can vary significantly, many cardholders now appear to have cards with lower interest rates than those offered in the past; data from the top six issuers reported to GAO indicate that, in 2005, about 80 percent of their accounts were assessed interest rates of less than 20 percent, with over 40 percent having rates below 15 percent. The issuers also reported that 35 percent of their active U.S. accounts were assessed late fees and 13 percent were assessed over-limit fees in 2005. Although issuers must disclose information intended to help consumers compare card costs, disclosures by the largest issuers have various weaknesses that reduced consumers' ability to use and understand them. According to a usability expert's review, disclosures from the largest credit card issuers were often written well above the eighth-grade level at which about half of U.S. adults read. Contrary to usability and readability best practices, the disclosures buried important information in text, failed to group and label related material, and used small typefaces. Perhaps as a result, cardholders that the expert tested often had difficulty using the disclosures to find and understand key rates or terms applicable to the cards. Similarly, GAO's interviews with 112 cardholders indicated that many failed to understand key aspects of their cards, including when they would be charged for late payments or what actions could cause issuers to raise rates. These weaknesses may arise from issuers drafting disclosures to avoid lawsuits, and from federal regulations that highlight less relevant information and are not well suited for presenting the complex rates or terms that cards currently feature. Although the Federal Reserve has started to obtain consumer input, its staff recognizes the challenge of designing disclosures that include all key information in a clear manner. Although penalty charges reduce the funds available to repay cardholders' debts, their role in contributing to bankruptcies was not clear. The six largest issuers reported that unpaid interest and fees represented about 10 percent of the balances owed by bankrupt cardholders, but were unable to provide data on penalty charges these cardholders paid prior to filing for bankruptcy. Although revenues from penalty interest and fees have increased, profits of the largest issuers have been stable in recent years. GAO analysis indicates that while the majority of issuer revenues came from interest charges, the portion attributable to penalty rates has grown.
Recommendation for Executive Action
Status: Closed - Implemented
Comments: The Federal Reserve Board published a final rule on January 29, 2009 that amends Regulation Z by improving the disclosures consumers receive in connection with credit card accounts, and which satisfies our recommendation (see 74 FR 5244). We recommended that the Chairman of the Federal Reserve ensure that consumer disclosures, including model forms and formatting requirements, more clearly emphasize those terms that can significantly affect cardholder costs, such as the actions that can cause default or other penalty pricing rates to be imposed. The final rule makes several revisions that seek to improve consumers? understanding of default or penalty pricing. One such change requires card issuers to include additional information inside the summary table provided in credit card applications and solicitations, including actions that trigger penalty APRs and the rate that would apply. Before the final rule, these terms were disclosed outside the summary table. Also, the final rule requires disclosure of fees in this summary table, including fees for paying late, exceeding a credit limit, or making a payment that is returned. Another such change affects the periodic statements card issuers provide monthly to cardholders. The final rule requires card issuers to disclose all fees together and to separately itemize interest charges by transaction type, as well as to disclose the total fees and total interest imposed for the cycle, as well as year-to-date. Before the final rule, card issuers typically disclosed fees and interest charges with other transactions, such as purchases, chronologically on the statement. The Board also published model forms that complement this new rule. Also on this date, the Board published rules that amend or prohibit several practices that we reported could significantly increase cardholder costs, but on which we did not issue recommendations. An amendment to Regulation Z extends the length of time card issuers are required to provide consumers with notice of changes to various terms, including penalty APRs, from 15 days to 45 days before the change takes effect. Under a separate rulemaking affecting Regulation AA (Unfair or Deceptive Acts or Practices), the Board requires issuers to allocate consumer payments that are in excess of the minimum amount due either by applying the entire payment amount first to the balance with the highest annual percentage rate or by splitting the amount pro rata among balances subject to different rates. Finally, this rule prohibits two- or double-cycle billing practices in which issuers reach back to earlier billing cycles when calculating the amount of interest charged in the current cycle. The Board reported that it reviewed our report to inform its rulemaking.
Recommendation: As part of its effort to increase the effectiveness of disclosure materials used to inform consumers of rates, fees, and other terms that affect the costs of using credit cards, the Chairman, Federal Reserve should ensure that such disclosures, including model forms and formatting requirements, more clearly emphasize those terms that can significantly affect cardholder costs, such as the actions that can cause default or other penalty pricing rates to be imposed.
Agency Affected: Federal Reserve System