Avoid Your Credit Card Penalty Rate, It May Last Forever

Stressed woman paying bills
••• JGI/Jamie Grill

Federal law allows credit card issuers to impose a penalty interest rate if you become more than 60 days delinquent on your credit card payment. As the name suggests, it's a sort of punishment for your missed credit card payments. You lose the interest rate you’re currently enjoying, even if it's a promotional rate, and your finance charges will be calculated under the much higher penalty rate for at least six months.

The current 60-day delinquency requirement far better than the industry norm from a few years ago when credit card issuers could enact the penalty rate after just one missed payment. The increased period of delinquency before a penalty rate could be imposed was one of the consumer credit card protections included in the Credit CARD Act of 2009.

The chart below shows credit card delinquency rates from 1991 through the present.

Loophole to the Six-Month Penalty Rate Expiration Rule

The penalty rate won't last forever as it did in years past. Card issuers are required to lower your penalty rate back to the regular interest rate after you’ve made six consecutive timely payments, but that only applies to the balance that existed when the penalty rate was imposed. It doesn't apply to purchases made after the penalty rate became effective. Many credit card issuers are keeping the penalty rate for new purchases and continuing to punish you for your two-month mistake as long as use that card.

Read your credit card terms (found at your credit card issuer’s website, available upon request, or in the Federal database of credit card agreements) to learn your penalty rate and whether your card issuer leaves it in effect for new purchases. The section labeled "Your penalty rate and when it applies" will specify if it applies whether your penalty rate can be applied indefinitely.

Make sure you understand what triggers the penalty rate, e.g. paying late, having a payment returned, going over your credit limit or all of the above. If you have multiple credit cards or loans with a single lender, defaulting on one of those accounts can trigger the penalty rate on your other account. Note that credit card issuers are no longer allowed to raise your rate based on your actions with accounts with other creditors and lenders (this practice was known as universal default).

Penalty Rates from Major Credit Card Issuers

Here are the penalty rate clauses from a few major credit card issuers (as of November 2013):

American Express: If the Penalty APR is applied, it will apply for at least 6 months. We review your Account every 6 months after the Penalty APR is applied. The Penalty APR will continue to apply until after you have made timely payments, with no returned payments during the 6 months being reviewed. The Penalty APR will apply to existing balances only if a payment is more than 60 days late.

Bank of America: If your APRs are increased, the Penalty APR will apply indefinitely. Your Penalty APR will not exceed 29.99% on new transactions. There is no Penalty APR on existing balances.

Capital One: If APRs are increased for a payment that is late, the Penalty APR may apply indefinitely. Capital One will periodically review any rate increase to your account for a possible rate decrease.

Chase: If your APRs are increased for any of these reasons, the Penalty APR will apply indefinitely. The reasons are a failure to make the minimum payment on time, exceeding your minimum payments (when applicable), having a payment returned, or doing any of these things with another Chase account.

Citi: If your APRs are increased for either of these reasons, the Penalty APR may apply indefinitely. With Citi, the reasons for a penalty rate are a late or returned payment.

Discover: No penalty rate for the Discover it cards

PenFed has one of the more generous Penalty APR clauses: If your minimum payment is not received within 60 days, your entire account is subject to change to the non-variable Penalty APR. The Penalty APR will remain in place until you make three consecutive monthly payments on or before the due date.

IberiaBank and Wells Fargo do not list a Penalty APR in their credit card agreements.

If You Get a Penalty Rate That Doesn't Expire

If you trigger the penalty rate on a credit card that leaves it in effect indefinitely, realize that all your new purchases will be charged interest at the higher APR, even after the penalty rate expires for your previous balance. Your new charges will have much higher finances charges and will be more expensive to pay off. This also means you'll be carrying balances with different interest rates and your payments are subject to payment allocation rules. Minimum payments will go toward the balance with the lower interest rate. Only payments above the minimum will reduce the higher rate balance.

Being that the penalty rate is often close to 30%, and sometimes higher, creating new balances under that interest rate isn't wise unless you plan to pay your balance in full every month.

Make sure you understand what actions will cause the penalty rate so you can avoid having it imposed at all, even if it expires after 6 months on your credit card. For credit cards that don’t have a penalty rate, be aware that there may be punitive fees instead, e.g. a late payment fee, that is equally unattractive.