New credit card rules: What clients should know

The Department of Finance has rolled out new credit card legislation that will effectively reduce some of the costs of borrowing for Canadian credit card users.

The most important initiative is the creation of the Credit Business Practice Regulations, which govern business practices of credit card issuers the government deems harmful to consumers.

The most significant proposal that may be noticed by clients is the creation of a 21-day grace period on all credit card purchases. Currently some card issuers offer 15- to 24-day grace periods on new purchases when a customer pays the outstanding balance in full. Other issuers tally interest in that period if there is an outstanding balance carried forward from the previous period.

The government proposal provides a 21-day grace period that applies to all new purchases when consumers pay in full in the current month, regardless of whether there is an outstanding balance from the previous month. The consumer would only owe interest on the previous month’s outstanding balance.

Unfortunately, this doesn’t motivate card users to be any more prudent with their spending. Generally, it’s prudent to pay off previous debt before adding more debt to a credit card balance. That incentive would seem diminished with this rule.

Also, certain merchants place holds on a credit card to ensure the balance is accounted for on the card holders credit. It takes time for the transaction to be fully processed and the hold released, and a card holder could inadvertently go over their credit limit and incur fees while a hold is in place. The legislation prohibits financial institutions from imposing a fee when the credit limit is exceeded solely because a hold was placed on available credit.

Paying off high interest balance first

The new legislation will require financial institutions to cease the practice of automatically allocating payments above a minimum repayment to outstanding balances with the lowest-interest rates if a borrower has multiple balances with different rates.

The previous practice allowed lenders to make more money from borrowers, because the higher interest balances will grow at a faster compounded rate. The new measure in the legislation requires banks to allocate payments made in excess of the required minimum either to the balance with the highest interest rate first, or distributing the payment proportionately, based on the size of each balance.

Transparency measures

The new legislation will also require credit card issuers to get permission from a card holder before they increase the credit limit. Issuers will be required to either call the consumer or mention in their monthly statement that they have been approved for extended credit. Issuers will not be allowed to automatically extend the credit limit without the expressed consent of the consumer.

Another transparency measure, which is being proposed as an amendment to the Cost of Borrowing Regulations will require credit card companies to provide clear information on statements about any impending changes to a client’s account, and the implications of certain payment methods.

Also, credit contracts and credit card applications will be required to have a summary box that is easy to understand and includes information such as annual interest rates on new purchases, cash advances and balance transfers. The box will also be required to highlight the grace periods a client has before interest is accrued as well as how minimum payments are calculated.

The government wants issuers to explain the implications of only making the minimum payments on a credit card balance — a common topic many advisors have to address with clients.

Issuers would be required to disclose how long it would take a card holder to pay off a balance owing on a credit card if they only make minimum payments, demonstrating the effect of compound interest.

For example, the government backgrounder on the legislation highlights that it could take more than 10 years to pay off a $1,000 balance compounding at 18%, if the card holder only makes the minimum payment each month on that balance.

Card issuers will also be required to provide clients with advance notice of any impending interest rate increases. The government says clients would be reminded of situations such as rate increases following the end of low introductory rates or rate increases triggered by the consumer skipping one or more minimum payments.

And lastly, the proposals prohibit financial institutions from contacting clients after 9 p.m. on weekdays and Saturdays and after 5 p.m. on Sundays.

Concerns about implementation

In a statement to Advisor.ca, the Canadian Bankers Association (CBA) pointed out that it appreciated the concerns reflected in the proposals, but highlighted that there could be “unintended consequences” for consumers as a result of the legislation.

“While the full implications of these proposed regulations are still unclear, we do know that they will have a big impact on banks that issue credit cards. These regulations will require significant changes to product systems and processes. Our credit card systems are extensive and sophisticated and implementing these regulations will be costly,” the CBA spokesperson says.

“These regulations may also limit the banks’ ability to provide some of the services customers have come to expect, limit the number of credit card options and may reduce credit availability to some customers. And they come at a time when banks, like all other sectors, are feeling the effects of the recession, and when banks face increasing risk associated with credit cards.”

The CBA also expresses concern that the measures don’t reflect the reality of many Canadian credit card users, who tend to use credit cards differently than their U.S. counterparts.

The CBA notes that Canadians use credit cards primarily as a payment card whereas Americans tend to use it as a credit vehicle. Over 70% of Canadians pay off their credit card every month, compared to only half of Americans.

In addition, the CBA says Canadian credit card pricing structures are different and tend to have far fewer, and far lower, fees than cards in the U.S. For example, late payment fees are common south of the border and in much of the rest of the world, but are not applied by issuers in Canada.

“Banks do not believe that imposing U.S.-style solutions on a well-functioning Canadian credit card market is necessary or effective. The Canadian market is very different from that of the U.S.,” explains the CBA. “In Canada we already have strong consumer protections in place for credit card users and federal regulations that require banks to fully disclose information about terms, fees, and interest rates to their credit card customers at the time of application and in advance when changes are made.”

(05/21/09)