Why you should pay an annual credit-card fee

NEW YORK (CNNMoney.com) -- In most instances today, it would be silly to pay an annual fee for a credit card simply because most cards don't have them anymore.

But in a Senate Banking Committee hearing examining credit card practices this week, one consumer advocate suggested those who pay their balances in full every month (about half of all cardholders) should pay a small annual fee to credit card companies.

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Why? To pay their fair share.

Say you charge $1,000 at the beginning of every billing period and pay it off in full by its due date a month or so later. That's essentially an interest-free loan from the credit card company to you.

The affectionate term of art for those of us who do this is "deadbeat" because we're not that profitable for the credit card companies. Sure, issuers make money off of you through fees paid by merchants whenever you charge a purchase. And you're deemed a "valued customer" because you make an issuer's portfolio look better when they show it to the securities markets.

But let's face it, such model behavior on your part isn't going to plow record profits into an issuer's pockets.

A recent report from the Government Accountability Office estimated that about 70 percent of the credit card industry's revenue comes from interest and penalty rates, with penalty rates accounting for a growing portion. Senate Banking Committee Chairman Christopher Dodd (D-Conn.), meanwhile, noted that for 2006, banks are expected to collect a record $17.1 billion in credit card penalty fees, up 15.5 percent from 2004 and up 906 percent from the $1.7 billion it collected in 1996.

When it comes to the bottom line for issuers: Bad is good.

Those who carry balances on which they pay interest and fees are subsidizing cardholders with no revolving balance who may even be in rewards programs, said lawyer Michael Donavan of Philadelphia-based Donavan and Searles. He represents those who have unwittingly fallen into many of the sandtrap fees and penalties embedded in hard-to-understand credit card agreements.

Restoring small annual fees on cards used by "non-revolvers" would bolster revenues for card issuers, who then in turn might not make life so expensive for those with revolving balances.

A lot of time at the Senate hearing, which included witness testimony from representatives of three credit card issuers -- JP Morgan Chase, Capitol One and Barclays -- was spent discussing (and agreeing about) the need to improve the disclosure of the terms of the credit card agreement -- to make it more straightforward and easier to understand.

But, Donovan testified, "it's not a question of financial literacy and never will be." The problem as he sees is it is the ability of credit card issuers to change the terms of the agreement with just 15 days' notice.

"The credit card is one of the only contracts in common law anywhere in which the superior bargaining entity can change its terms at anytime for any reason," Donavan said. "If they can change the contract on an existing balance, then they will always have an unfair advantage."

His suggestion: Issue cards with shorter expiration periods. So, instead of five years, make it one, he said. When the card comes up for renewal, then the issuer would be free to change its terms.

Other consumer advocates at the hearing testified that consumers deserve more than just better disclosure. They called for the prohibition of what they classify as deceptive and abusive practices.

Harvard professor and bankruptcy expert Elizabeth Warren, who considers some credit card pricing practices "the tricks and traps that keep [card customers with balances] on the financial ropes," said thanks to safety standards, "no one has to be an engineer to buy a toaster. No one has to be a crash test expert to buy a car. It's time for safety regulations in credit card products as well."

Among the practices she and others at the hearing said they'd like banished:

• Universal default pricing: With this policy even if you have a sterling payment record on your card account, your issuer may jack up your rate if you're late on bills on other accounts or if your credit score falls. The number of issuers with this policy has gone down recently.
• Double-cycle billing: If you charge $1,000 one month, and pay off $900, a bank may charge you interest on the full $1,000 in the next month and beyond until the remaining $100 is paid off. Carter Franke, executive vice president of marketing at JP Morgan Chase, said that due to customer confusion, the bank decided very recently to end its practice of double-cycle billing. She did say, however she didn't feel it was an unfair practice, likening it to a bank loan, where you start paying interest immediately on the full amount, not just a portion of the principal.
• Zero-tolerance late payment policies: Tamara Draut, director of economic opportunity programs at Demos, noted that customers who may be a day late or even an hour late in their payment are often hit with the same $35 late fee as customers who might be three months' late. Being subject to a couple of late fees may also result in a penalty rate imposed on your account, which can top 30 percent. And that punitive rate may then be applied not only to future purchases but to an existing balance as well, effectively boosting the cost of the cardholders' past purchases.

Sen. Dodd noted that Thursday's hearing would be the first of several to examine credit card practices. It's not clear whether any legislation would result from the effort or whether lawmakers and the credit card industry might try to come to an agreement on best practices.

But Dodd did issue a warning to credit card companies during the hearing: "If you currently engage in any business practice that you would be ashamed to discuss before this Committee, I would strongly encourage you to cease and desist that practice. Irrespective of the current legality of such practices, you should take a long, hard look at how you treat your customers."

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