Getting Caught in the "Death Zone" of the Debt Life Cycle
The saying goes that the bold print giveth and the fine print taketh away, when it comes to contracts. This is especially true in the case of credit card agreements. Nearly all creditors include a default interest rate in the contract that is significantly higher than what you pay when you maintain timely payments on your account.
What Is A Default Rate?
A default interest or penalty rate is a higher interest charge that goes into effect if you fail to make payments on time. The rate will typically apply to any outstanding balance on the account and can remain in place for the life of the credit card. The challenge with penalty rates is that if you are struggling to pay your bills, this higher rate on top of late fees makes it even harder to catch up a delinquent account, reducing the chances you will be able to pay the debt off.
Conditions That Cause the Default Rate to Go Into Effect
Many contracts stipulate that the default rate can go into effect with as little as one missed payment. Typically, the language of a credit card agreement states: “This APR (Default annual percentage rate) may be applied to your account if you make a late payment… (Penalty rate) may apply indefinitely.”
Generally, if you miss two payments or become 60 days late on an account, the default rate will be enacted. Exceeding your credit limit or having a payment returned can also trigger the default or penalty interest rate.
Regulation Regarding Default Rates
Catching up the account and making 6 on time payments is usually required to reduce your interest rate back to the original agreement on outstanding balances. Some agreements state the default rate can continue to be charged on new purchases. Reading your agreement and understanding the terms will help prevent the default rate from being activated.
Avoid Getting Caught in the “Death Zone”
As mentioned previously, the default interest rate usually kicks in when your account goes 60 days past due, and will remain in effect until the account is paid in full or you are able to bring the account current and make 6 consecutive months of on-time payments. The further into delinquency you go, the harder it usually is to get the account back to a current status. This increase in interest charges and penalties for late payments and over balance fees can quickly add hundreds or thousands of dollars each month to your balance. Getting caught in the “Death Zone” of the debt life cycle can lead to financial ruin as your balances continue to climb each month until the account is paid off or the creditor writes off the account for non payment, also called a charge off, which occurs after 180 days of non payment. After Charge off, the accrual of interest, penalties and fees is stopped and the account may be sold to a third party debt buyer for further collection action or legal recovery.
Life Cycle of a Charge Off
- Current: rate based on credit card agreement
- 30 Days Late: Late fees incurred and the late payment or missed payment is generally reported to credit bureaus. This will usually trigger a significant drop in credit score.
- 60 Days Late: Default rate kicks in and will remain until account is current for 6 months.
- 90 Days Late: Higher interest rates and late fees continue to accrue on the account in addition to outstanding balances.
- 120 Days Late: Account often turned over to a collection agency. Potential for a lawsuit to be filed in an effort to collect payments. Late fees and interest continue to accrue.
- 150 Days Late: Late fees and penalties continue to accrue.
- Charge Off: Late fees and penalties stop accruing and the account is often sold to a collection company or debt buyer.
The “Death Zone” for interest and penalties is between 60 days late and charge off. Attempts to bring the account current will include all penalties, fees, and higher interest rate. During the “Death Zone” period, negotiating the debt makes it possible to reduce these fees and interest rate and bring a resolution to debt that is spiraling out of control.