You probably know that your credit card interest rate is determined by a the credit card company’s assessment of your risk factor. If they believe that your credit history translates into a high risk, you’ll be issued a higher interest rate on your credit card. What most people don’t know is that the interest rate they are first offered with a credit card contract isn’t set in stone. Not only can the bank raise your interest rate if you are late on your credit card payments, but they can also increase the APR if you are late on other bills. This is the concept known as the “universal default clause”, and is something you should consider.
Credit card contracts are notoriously difficult to decipher, which is why most people miss the universal default clause. The wording might be confusing or so packed with legal jargon that the meaning is all but lost to the casual reader. The problem is that your interest rate could be increased without your knowledge until you receive your next bill, which might be quite a shock.
The reasoning behind the universal default clause is simply protection for the bank. Your risk factor determines how likely you are (in the bank’s eyes) to pay back your debts. If you rack up $10,000 in credit card charges, will you make good on your payments or allow them to fall into collections? The bank wants to be assured of getting their money back, and they assume that you will pay back debts with high interest faster than you would with a low APR.
There is quite a bit of controversy surrounding the universal default clause, particularly because the bank is using debts other than their own to determine your risk factor. Most commonly, the bank monitors your mortgage and car note payments to ensure that you are paying those bills on time. If you are late on a payment — even by a day or two — you could wind up with a 10% increase on your credit card APR.
The universal default clause is in addition to late payments on your credit card itself. Several times, the Supreme Court and other U.S. courts have upheld that you can be late by only a few hours on your credit card payment, but still incur late charges, as well as other penalties — like an increased APR.
So how do you protect yourself from the universal default clause?
Obviously, paying all of your monthly bills on time is the best way to avoid penalization. The credit card company might monitor your credit report monthly, quarterly, annually or even less often, but you don’t want to take any risks. If you know that you’ll come up short at the end of the month, pay your largest bills first, and call the providers on your smaller bills to make arrangements.
Some people (myself included) have a hard time remembering to pay all of their bills on time. To avoid this calamity, sign up for EFT or automatic payments from your credit card, debit card or bank account. This ensures that all of your bills will be paid on a timely basis and you’ll avoid the risk of having the universal default clause invoked.
You should also shop for credit cards that don’t have universal default clauses at all, which is becoming increasingly difficult. Read the fine print on credit card contracts carefully and have an attorney look them over if you don’t understand. You can also call the financial institution providing the credit card and specifically ask if a universal default clause is in place. They have to tell you the truth, and this will save you quite a bit of trouble in the future.