Avoid ‘universal default’ credit cards

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Dear Debt Adviser,
I just got a mailed notice that if I “default” on my credit card, the lender will raise the “default APR” to 33.49 percent and will apply it to my $660 credit account. I am not in default, nor do I foresee this occurring, but this rate is so high that I want to close that account so that I never have to pay it.

I have a high credit line on this card, and I know you often advise people to keep a credit line open. But to me, this is just not worth the risk. It seems the credit card company can do whatever it wants. Do you have any advice for me?
— Lee Ann

Dear Lee Ann,
First, let me congratulate you for opening and reading your mail from your creditor. Many people would have thrown the notice that you received in the trash and never known about the “default” rate.

I understand your inclination to close the account so you will not have to worry about ever having to pay an outrageous 33.49 percent interest rate. It used to be that only guys named Lucky or Big Al got to charge 33.49 percent! Welcome to the world of risked-based credit pricing.

In order to extend credit to as many people as possible, lenders put stiff penalties on defaults to compensate them for the additional risks they are taking, even if you are not one of their risky customers.

Bob Dylan said it right: “They make the rules for the wise men and the fools.”

However, I do want you to consider some things before you close the account. Your account may not have “universal default,” which allows lenders to apply a higher interest rate if your credit report shows any change that has lowered your credit score.

Instead, your account may have a standard default clause that can only be activated if you do not pay on that particular account.

Check your card agreement and see if you have a “universal default” clause. If you don’t, then you need only pay on time each month and you will not have to worry about the default rate.

Universal default cards are to be avoided if possible. Your rate can be raised even if you are never late on your main account but are late on paying other accounts. The rate can also be raised if lenders believe that your risk profile has changed. Lenders are moving away from this policy, so you should be able to find alternatives out there.

You have not accessed the account very much, yet have a high credit limit and long history associated with the account. These are positives for your credit history. Closing the account could negatively affect your credit score.

Rather than closing the account, consider paying off the balance on this card and keeping it open. Use it for charges that you will pay off each month. Or, just put it in a drawer until the creditor changes its policies. If you need a card to carry a balance for a few months, get a new card that does not have a universal default clause. The new credit account will cause a slight dip in your credit score, but not enough to cause significant worry.

If you do decide to close the account and open another one, just know that your credit score may drop and it may take a little time for it to recover.

The Debt Adviser, Steve Bucci, is the president of Money Management International Financial Education Foundation and the author of Credit Repair Kit for Dummies. Visit MMI for additional debt advice or to ask a question of the Debt Adviser go to the “Ask the Experts” page.