The Penalty (or Default) APR is the interest rate applied to a portion or your entire balance once your credit card is in default. The rules for when the Penalty APR applies are different for general consumer credit cards and small business credit cards, as small business credit cards were excluded from the new credit card law (Credit CARD Act). Below you will find separate explanations of how the Penalty APR works for both types of credit cards.

Consumer Credit Cards:

The Penalty (or Default) APR for general consumer credit cards is the interest rate applied to a portion of your credit card balance when you do not follow the terms and conditions of your credit card agreement. The Credit CARD Act, effective February 2010, made changes to the rules for the Penalty APR and when it applies to different portions of your balance. More specifically, the Credit CARD Act states that the only way a credit card company can apply the Penalty APR to an existing balance (i.e. purchases you have already made) is if you are 60 days delinquent in making a minimum payment.

A re-pricing of your APR for any other reason can only affect future transactions, and cannot occur in the first 12 months of your agreement. Unfortunately, a rate increase that applies to future transactions does not have restrictions under the Credit CARD Act and can happen for any reason the credit card company wants (including missing one payment or going over your credit limit). If the credit card company changes your interest rate, it is required to send you a notice specifying the reason for the rate increase 45 days in advance, and the rate increase can only apply to purchases made 14 days after the notice was sent. It sounds complicated, but these rules are actually an improvement.

The new credit card law also provides specific guidelines for how to get back to the regular APR for your existing balance after the Penalty APR has been triggered. The law states that once the rate is increased on an existing balance because you were 60 days delinquent, the credit card company must move you back down to your non-penalty APR once you have made timely payments for 6 consecutive months.

The problem is, this rule only applies to existing transactions. Therefore, once you have triggered the Penalty APR, the credit card company can apply the Penalty APR to future transactions at any time as long as it sends you notice. Fortunately, the Credit CARD Act also created provisions that require credit card companies to re-evaluate a rate increase every 6 months and, if appropriate, it must reduce your rate within 45 days after completing the evaluation.

Our Recommendation to Avoid the Penalty APR for Consumer Credit Cards:
You can protect yourself from missing payments by calling your credit card company and signing up to have your minimum payment automatically deducted from a checking account each month. This arrangement is called ACH or Automatic Bill Pay and is made directly with your credit card company. Additionally, if the Penalty APR is applied to your balance for a reason other than being 60 days delinquent and you feel the rate is too high, we recommend that you stop using that card to make any new purchases. This way you can pay down your balance for existing purchases at your own pace and at your regular APR, without worrying about being charged an unmanageable Penalty APR for new purchases.

Business Credit Cards:

The Penalty (or Default) APR for small business credit cards is the interest rate applied to your balance once your credit card is in default. The triggers for the Penalty APR vary for different credit cards, but generally include missing one payment, going over your credit limit, or making a payment that is returned.

Penalty APRs are usually above 20 percent and apply to the entire credit card balance. Some credit cards have a different Penalty APR for cash advances, which is referred to as the ‘Cash Penalty APR’ and is usually higher than the Penalty APR applied to purchases and balance transfers.

It is very important to protect yourself from the Penalty APR, particularly if you carry a large balance on your credit card (as many small business owners do). Let’s say, for example, that you have a credit card with a regular APR of 10 percent and a balance of $5,000. If you miss a payment and a 20 percent Penalty APR is applied to your balance, it will cost you an additional $500 each year!

Our Recommendation to Avoid the Penalty APR for Small Business Credit Cards:
Because of small business credit cards exclusion from the Credit CARD Act, you shouldn’t use them to carry a large balance. It is our recommendation that you use a general consumer credit card for purposes such as funding (when you need to carry a large balance) and only use small business credit cards for purposes that you know will pay back in full right away. Using a general consumer credit card for carrying a balance will ensure that you are protected from unexpected interest rate increases on your existing balance.

Make sure you are aware of what will activate the Penalty APR on each of your credit cards. Call the customer service telephone number for each of your cards and speak with an agent to make sure you understand the Penalty APR trigger for each of your credit cards. You can also read the terms and conditions sheet that you received when you applied for your credit card. These terms are subject to change, however, so make sure you have the most recent information.

You can protect yourself from missing payments by calling your credit card company and signing up to have your minimum payment automatically deducted from a checking account each month. This arrangement is called ACH and is made directly with your credit card company.