Dodging the Default Rate

Credit cards come with several different APRs: one for purchases, sometimes another for balance transfers, and a higher APR for cash advances. The highest APR of all is the default or penalty rate. The default rate is only charged in certain circumstances and thankfully, there are ways to avoid the expensive APR.

Regular APR vs. Default APR

Typically your transactions will get the regular rate for that type of transaction, e.g. purchases get the purchases APR, balance transfers the balance transfer APR, and so on. The default rate is triggered as a penalty for certain actions on your credit card.

There are three things you can do to trigger the penalty APR: fall delinquent on your account by 60 days, exceed your credit limit, or have a returned payment. Once it’s triggered, the default rate can apply to all your balances: purchases, balance transfer, etc. Each month, your finance charge will be calculated using this higher interest rate instead of your previously much lower interest rate.

Limits on the Default Rate

There’s good news and bad news for you if you’re ever faced with the default rate on your credit card. The good news is that your card issuer is required to lower your default rate back to the regular rate after six months of timely payments, if your rate was raised because of a 60-day delinquency. The bad news is that they’re only required to lower the rate on your existing balance. Your card issuer can continue to apply the default rate to any new purchases made after the rate was triggered, and many of them do. That’s another great reason to avoid the default rate.

Just a few years ago, credit card issuers engaged in a practice known as universal default. A card issuer could impose the default rate because of something you did with another credit card. For example, the rate on your Credit Card A might increase because you were late on a payment to Credit Card B. Thankfully, the Credit CARD Act of 2009 outlawed this practice. Credit card issuers are no longer allowed to raise your interest rate because of something that happened with a card from another credit card issuer.

Cost of the Default Rate

Many people don’t understand the severity of the default rate because they don’t realize what it means for their wallet. Consider a $1,000 balance at 14.99% APR. Your finance charge for a month would be $12.42. But, if a default rate of 29.99% was applied to the balance, your finance charge would instead be $24.99, a little more than double what you’d pay under the regular interest rate. And remember this is the rate you’re charged for at least six months.

Because the finances charges under the default rate are so high, less of your credit card payment will go toward reducing the credit card balance. Unless you increase your monthly payment, the default rate will slow down your progress in paying off your credit card balance.

Steps to Avoid the Default Rate

Avoiding the default rate isn’t hard. Just use your credit card responsibly. Pay your credit card on time, avoid going over your credit limit, and be sure there’s enough money in your checking account when you pay the bill. If you have a credit card that doesn’t repeal the penalty rate for new purchases, it’s best to pay off the card only use it periodically to keep it open. That’s if you want to keep the credit card open and active.