What the CFPB’s proposed $8 credit card late fee cap could mean for cardholders

You could pay a lot less in the future if you are late with a credit card payment.

While a late payment today can incur a penalty of as much as $41, a recent proposal from the Consumer Financial Protection Bureau (CFPB) would reduce that penalty fee to $8. That would reduce total credit card late fees by up to $9 billion a year, according to the agency.

The agency has invited public comment (with an April 3 deadline) before making a final decision. The CFPB had also asked for public input last year before deciding how to proceed with its late fee rule.

While consumer advocates laud the CFPB’s proposal, many in the banking industry are opposed.

The issue: Late fees do not reflect issuer costs

In a press release announcing the proposal, CFPB Director Rohit Chopra said, “Over a decade ago, Congress banned excessive credit card late fees, but companies have exploited a regulatory loophole that has allowed them to escape scrutiny for charging an otherwise illegal junk fee.”

The CFPB is concerned that current late fee charges (up to $30 for the first late payment and up to $41 for a second late payment within six credit card billing cycles) do not reflect a card issuer’s costs to handle and collect late payments.

The fees could be as high as five times the issuers’ costs of collecting them, the CFPB estimates. Thus, they’ve become a source of profit for large credit card issuers.

Moreover, these high late fees may not be necessary to deter consumers from making late payments. That’s because consumers already face additional consequences, the CFPB says, including lost grace periods for payments and a potentially lower credit score.

Taking this into consideration, the CFPB is looking to make these changes:

• A late fee cap of $8. However, issuers can charge a higher late fee if they are able to justify it based on the costs they incur.
• No automatic inflation adjustment to the proposed $8 cap. Contrary to the current practice of adjusting the late fee cap each year based on inflation, the CFPB would monitor market conditions to decide whether to raise the cap.
• Alternative late fee cap of no higher than 25 percent of the minimum payment due. Currently, a late fee of as much as 100 percent of the minimum payment can be assessed (if the minimum payment due is lower than the late fee). The proposal would reduce that to a 25 percent maximum.

Opposition from industry groups

There are a few reasons why some financial industry groups oppose the CFPB’s proposal:

More Americans could face higher interest rates

Some believe a late fee cap could cause issuers to raise their interest rates to make up for lost revenue, and force smaller community banks to leave the market if they can’t recoup their costs.

The “extreme CFPB proposal” would harm consumers, the American Bankers Association said in a press release. “It will result in more late payments, higher debt and lower credit scores. If the proposal is enacted, credit card issuers will be forced to adjust to the new risks by reducing credit lines, tightening standards for new accounts and raising APRs for all consumers.”

It will affect not only cardholders who pay late, but also “the millions who pay on time,” according to the bankers’ trade group.

Access to financial products could be limited

The National Association of Federally-Insured Credit Unions (NAFCU), too, asserted in a press release that while the proposal looks to save consumers money on its face, it actually would “amount to financial chaos” by cutting access to credit for many Americans. The NAFCU warns that smaller community-based lenders such as credit unions may be forced to get out of the credit card market.

“In addition, institutions will likely be forced to raise the price of checking and savings accounts or other loan products and reduce the benefits of other financial programs, NAFCU President and CEO Dan Berger said. “This proposed rule, if finalized in its current form, will hit Americans hard.”

Added transparency for cardholders

The CFPB acknowledges in its proposal that card issuers may raise interest rates for subprime consumers if they lose revenues from late fees. But it also believes that would make the market more transparent, so that consumers know their true costs.

Since those consumers would know upfront what their credit costs would be (instead of incurring additional hidden costs from late fees), they can make an informed decision about whether they want that card.

However, if issuers do raise credit card interest rates to make up for lost revenue, those cardholders who carry a balance, but always pay on time, will pay a price. Issuers could also cut down on card rewards and raise other fees.

Support from consumer groups

Many consumer advocates, however, are in favor of the CFPB proposal.

For one, the National Consumer Law Center (NCLC) sees it as a big win for consumers, pointing to consumer savings. “Penalty fees that are too high are harmful, because they create incentives for the more powerful party —  in this case credit card lenders — to engage in unfair tactics to trigger them,” says Chi Chi Wu, an NCLC staff attorney.

She adds that the Credit Card Accountability Responsibility and Disclosure Act (Credit CARD Act of 2009) cut down on many penalty fee abuses which led to “lucrative” late fee payments for issuers. “That is why it’s so critical for CFPB to make sure the late fee amounts are not excessive,” Wu says.

The Consumer Federation of America also supports the CFPB proposal. In a press release, the advocacy group said that late fees “disproportionately burden subprime consumers and consumers of color” and that the proposal will positively impact consumers’ financial health.

Will reduced late fees encourage late payments?

It’s possible that a reduced late fee may disincentivize some consumers from making payments on time. However, there are other consequences to late payments that deter consumers from being late.

For instance, they could lose the grace period for avoiding interest on card balances. And if they don’t make at least a minimum payment for more than one billing cycle, they’ll face the prospect of higher penalty interest rates.

There are also credit impacts. After more than 30 days without payment, issuers can report a delinquency to credit bureaus. Delinquency may result in a reduced credit line, suspended card usage or cutting down on redemption of rewards.

Lenders could also start collection action. And after six months of delinquency, the issuer may charge off the account, resulting in a blemish on the consumer’s credit report for up to seven years.

According to the CFPB, these deterrents alone create an incentive for consumers to pay on time, even with a reduced late fee penalty. However, a lower fee could give some consumers an option to manage financial distress at a lower cost when necessary.

The bottom line

The CFPB is inviting public comment on its proposal to lower credit card late fees to $8 through April 3. Lower fees may help some cardholders manage their situation at a lower cost during periods of financial difficulty, the CFPB believes.

Industry groups have opposed this proposal, saying that banks would likely take card interest rates up and cut down on card rewards because of increased risks and lower revenues. Consumer advocates see it as a money-saving move for consumers, however.

Even without today’s high late fees, there are still consequences to your credit score and interest rate when you pay late. That’s why you should always aim to make your card payments on time and practice good credit habits.