Avoid Penalty Points for Missed Payments

Avoid Penalty Points for Missed Payments


The fallout from delinquent subprime mortgages continues to illustrate how inter-connected our financial system truly is. Because of a penalty known as "universal default," a late payment on a mortgage can cause the interest rate on your credit card to rise.

In the wake of the surbprime mortgage crisis, credit card companies have moved to their battle stations, carefully keeping watch over potential credit problems. After observing countless financial institutions lose millions on defaulted mortgages, they're pricing their products to reflect potential risks. People with bad credit are now paying more than ever before, and their interest rates are also being adjusted upward based on a provision called universal default.

Domino effect

Credit card companies base their interest rates on a person's credit score. The higher the score, the lower the rate. When a financial institution issues a piece of plastic, their contracts generally allow them to change the interest rate. This is the case with the universal default provision.

These companies monitor the scores of their cardholders, and they react if they observe risky financial behavior. If, for example, a cardholder makes a late payment on his mortgage, the credit bureau will report a lower score. The credit card company sees the reduced score, and assumes that the customer is stumbling financially and could be a potential risk. Despite the fact that the cardholder's late payment was on his mortgage and not the credit card, the financial institution may raise interest rates to compensate for the potential risk.

Preventive maintenance

Unless you've got a card that excludes the universal default provision, there's not much you can do to stop the credit card company from raising your rate. Ideally, you should check your contract carefully, ensuring that it doesn't contain such provision. However, if you find that your current card has it, there are two ways to avoid the penalty.

The first is to get another piece of plastic without the default charge. The other is to make sure that your credit score never dips by making timely payments on all your accounts. Set up automatic withdrawals from your bank account on big ticket items like your home or car payment, and keep up on all your other bills. Consider using online payment systems so that you don't have to worry about a check getting lost in the mail. Also, make sure that you don't take on more debt than you can handle, as that can also lower your score.

The universal default provision is yet another example of how skittish financial institutions have become in the wake of the subprime mortgage crisis. By penalizing cardholders if they make a delinquent payment on other accounts, they're pricing for a potential credit risk. It's an example of how people with bad credit are being held to a higher standard-one that can, unfortunately, involve much higher interest rates.