A "dangerous cycle of debt" is trapping too many credit-card holders, making it increasingly difficult to protect their financial security, according to a report.

About one-third of cardholders pay interest rates in excess of 20 percent, according to a report from New York-based think tank Demos. Also, borrowers with one slip-up can incur a "cascade" of penalties and end up in a "trap" of high-cost debt, the report said.

"The excuse of risk-based pricing is used to justify everything. These prices go far beyond pricing for risk. Some of these interest rates and payment fees seem to not accurately reflect the risk," said Tamara Draut, a co-author of the report.

Draut criticized practices such as card issuers retroactively applying rate increases. The authors also noted that companies can change terms at will, and that there are no legal bounds to the amount of fees and interest that borrowers can be charged.

"As a result, cardholders often borrow money under one set of conditions and end up paying it back under a different set of conditions," according to the authors.

Cardholders with balances and household incomes between $25,000 and $50,000 are almost two times as likely as households earning more than $50,000, and four times more likely than households earning over $100,000, to pay interest rates about 20 percent, according to the report.

Members of the House Financial Services Committee, including Reps. Barney Frank, D-Mass., and Carolyn Maloney, D-NY, are working on credit-card legislation that they hope to introduce in the fall. Sen. Carl Levin, D-Mich., has proposed legislation that would limit penalty interest rate increases and force issuers to take actions such as applying payments first to the card balance bearing the highest rate of interest.

Maloney has been concerned about a "perfect storm" in consumer credit that would be felt throughout the United States' economy.

On average, households that carry a balance on their credit cards owe more than $13,000, she has noted.

Lower-income households and young people may be at particular risk given their increasing use of credit cards. The Demos report found that low-income individuals, African Americans, Latinos and single females bear a disproportionate amount of credit costs.

Some practices that have come under particular public scrutiny are:

Double-cycle billing

The issuer computes interest on an original balance that had previously been subject to an interest-free period if a holder is late paying the balance on new purchases.

Universal default

The issuer increases rates when cardholders don't make payments to other creditors or have an overall decline in their credit score.

Payment allocation

The issuer applies payments first to the portion of an account with the lowest rate.

Most national bank issuers have already moved away from practices such as universal default and double-cycle billing, according to John Dugan, the comptroller of the currency, a position that makes him the administrator of national banks.

The Federal Reserve has proposed overhauling Regulation Z, which implements the Truth in Lending Act, to improve the disclosures that consumers receive for their credit cards by making the information timely and understandable. Disclosures with credit-card applications and solicitations would highlight fees and the reasons penalty rates might be applied.

Further, creditors would be required to summarize key terms at account opening and when terms are changed, and periodic statements would break out costs for interest and fees.

The Fed has received almost 200 public comments on its rulemaking proposal. Among them, Ruth Hasty of Houston wrote:

"Truth in lending is nonexistent in credit-card charges. The lenders can surreptitiously amass exorbitant late charges PLUS more exorbitant charges for exceeding the credit card limit. That is like a cruel parent tripping a child into a mud puddle then punishing the child for getting dirty."

The Demos report suggested these reforms:

Eliminating universal default terms by requiring that any penalty rate or fee increase be linked to a material default directly related to that specific account. Limiting penalty rate increases to no more than 50 percent above the account's original rate. Providing at least 30 days' notice a card issuer is invoking a penalty pricing clause. Prohibiting the retroactive application of pricing changes so that rate changes are applied only to purchases made after the issuer gives notice of the rate change. Ensuring that grace periods and payment posting rules and practices are not designed to trigger late charges and penalty rates for minor tardy payments. Requiring disclosure of the full costs of making only the minimum payments on a credit card, including the number of years and total dollars it will take to pay off the debt.

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