A growing number of readers’ e-mails to Bankrate are asking the same question lately: Should I opt out of this rate hike? Credit cardholders given the chance to avoid an imminent rate increase face a number of options, each with pros and cons.
No federal law or regulation requires issuers to offer cardholders a chance to reject a rate re-pricing, or opt out, according to Chi Chi Wu, a staff attorney for the National Consumer Law Center in Boston. Issuers may still present an opt-out in the name of goodwill or to comply with state law. Usually, but not always, opting out involves closing the account. The cardholder can’t use the card going forward but gets to pay it off at the old rate and under the existing terms.
Like most answers to credit card questions, the best course of action depends on your situation. Let’s explore some scenarios.
Paying off the debt
If you can wipe out the outstanding debt before the rate increase applies, this is the best move for your wallet and credit score. You will pay no additional interest charges and your score won’t suffer from an account closure. To keep the card active after the higher rate takes effect, use the card once a quarter to purchase something inexpensive and pay the balance off.
If the amount is too large to pay off and the rate increase is worthy of avoidance, see if you can do a balance transfer to another card. This leaves the original account open and paid off, which will help your credit score as you attack the balance on the new card. Scott Bilker, creator of DebtSmart.com, says he’d first look to his existing cards for balance transfer deals, then consider new credit cards if his didn’t offer any good rates.
It may prove tough for some to qualify for a better interest rate. For rates below 8 percent, you need a stellar credit score. “I’d say north of 720,” says Curtis Arnold, founder of CardRatings.com and author of “How You can Profit from Credit Cards.”
There’s also usually a cost involved with balance transfers. Balance transfer fees are typically 3 percent of the balance, but increasingly issuers are charging 5 percent of the balance with no cap on the fee, says Greg McBride, senior financial analyst at Bankrate.com.
Use this work sheet to plug in the costs. Note both the teaser balance transfer rate and the regular APR following its expiration.
If the math plays out in favor of a balance transfer, make sure not to charge new purchases until that balance transfer debt is paid off. Issuers will usually apply payments to lower-rate balances first to maximize profit.
If the opt-out involves an account closure, your credit score could suffer once the debt is paid off. The FICO scoring formula does not count the credit limits of closed accounts with zero balances when it calculates the debt-to-credit limit ratio, or utilization. You may appear more maxed out on your remaining cards after losing that available credit. Read the article “Why closing an account hurts score,” to learn more on this subject.
Saving money may trump the score damage in some situations. “For those that do not plan to be in the market for a mortgage or a car loan in the next six to 12 months, they should consider opting out and keeping the lower rate if given the opportunity,” says McBride.
People in the market for a mortgage should “swallow hard and take the higher rate because of the credit score,” he says. “(There’s) no sense paying a higher rate on a $300,000 mortgage because they didn’t want to pay a higher rate on a $3,000 credit card balance.”
Those who can afford a temporary dip in their score might do well to refuse the higher rate, depending on the savings and the lack of alternatives. McBride points out that a rate increase from 9 percent to 16 percent on a $3,000 balance would cost about $650 more in interest charges if the cardholder took five years to pay the balance. The cardholder could then pay down the debt to minimize the score damage.
McBride contends opting out can also make sense if you’re struggling to make the minimum payment now. A missed or short payment will hammer the score a lot more than a closed account.
Keep in mind the original APR isn’t guaranteed to stay in effect, even if you pay on time. You still want to pay down the debt as quickly as possible. “When you opt out, it’s going to be under the existing terms, and the existing terms are going to say, ‘Well, they can still raise the rate,'” says Bilker.
When you can’t pay the balance in full, when balance transfers aren’t an option and if you can take a score hit to save money, consider the opt-out route.
New federal regulations that take effect in July 2010 don’t address opting out but they will limit retroactive rate increases. Issuers will be able to apply a rate hike going forward with 45 days’ notice but won’t be able to impose it on existing balances unless the cardholder pays at least 30 days late, has a variable rate or if a promotional rate has expired.