What Is Penalty Repricing?

Penalty repricing—also known as behavior-based repricing—is the practice of increasing the interest rate of a loan based on the borrower's past behavior. Although penalty repricing can apply to various loans, it is most commonly used in relation to credit cards.

Key Takeaways

  • Penalty repricing is the practice of increasing the interest rate on a loan when the borrower fails to make full or timely payments.
  • It can also lead to other types of penalties, such as a one-time fee.
  • Credit card customers should be especially careful to avoid penalty repricing, because the increased interest rates can quickly cause an unsustainable interest burden.

How Penalty Repricing Works

From the perspective of lenders, penalty repricing is a risk-management tool to help protect against the risk of default by borrowers. A borrower who may appear to be low-risk could nonetheless fail to make full or timely payments. To protect against this risk, many lenders will include clauses in their loan contracts that allow them to increase the annual percentage rate (APR) on their loans should the borrower default. The Credit Card Accountability, Responsibility, and Disclosure Act of 2009 allows issuers to increase interest rates if the card holder has not made minimum payments for more than 60 days.

In some cases, penalty repricing can involve additional fees in addition to an increased APR. Depending on the circumstances, the lender may be entitled to receive immediate repayment of the full outstanding balance if the borrower fails to make timely payments. This dramatic move, colloquially known as calling the debt, can be devastating for borrowers. After all, most borrowers do not have adequate cash available to pay back their full loan balance on demand.

In practice, most lenders will exhaust all available alternatives before forcing the repayment of a loan. This is especially true for credit cards and other forms of unsecured debt, where lenders are far more likely to rely on increased interest rates. These rates, which are sometimes referred to as "default APRs," are designed to compensate lenders for any missed or late payments made by the borrower.

Real World Example of Penalty Repricing

Kyle is reviewing the cardholder agreement of his new credit card. In the section describing potential fees and penalties, Kyle notices the lender can increase the APR if he fails to make the minimum monthly payment after more than 60 days. In this scenario, Kyle would technically have defaulted on his loan, making him subject to penalty repricing. Under the penalty repricing clause, Kyle's credit card issuer could increase his APR from the normal rate of 25% up to a default APR of 35%. 

If faced with this situation, Kyle would be well advised to take all available measures to pay off his outstanding debt, in order to reduce his interest burden. One strategy would be to pay off high-interest debt using a separate loan offering a lower interest rate. That way, Kyle could reduce his monthly interest burden without increasing his total debt. In addition to this debt consolidation strategy, Kyle could also take measures to ensure he does not miss any monthly payments by accident, such as by signing up for an automatic payment program through an online banking platform.