Background
Under the theory and practice of risk-based pricing, the interest rate of the loan should reflect the risk of the borrower to avoid subsidizing those who default at the expense of those who always pay on time (or alternatively, to allow loans to be given to a broader range of customers, with a broad range of credit history).
Usually, if an interest rate is to be risk-based, the risk premium (or amount charged extra for the risk) is set at the time of an account opening. However, this does not take into consideration that the risk of a borrower defaulting may change later (or in fact the risk might be less).
Thus, while lenders have increased credit limits and lowered rates to borrowers in good standing, reflecting the decreased perception of risk, recently lenders have begun to raise rates to those it later has found have defaulted with other lenders.
This practice generally only happens on credit cards, which are one of the only forms of consumer credit to have an adjustable interest rate not simply based on an interest rate index but on the perceived risk of the customer (both positive and negative).
Instead of a specific increase in the risk premium charge, credit cards often change their interest rate to what is known as the default rate. This rate is usually the highest rate charged by the card, an average of 27.8%. In addition this is charged in a first in, last out FILO basis.
Normally the default rate is charged when a customer fails to make a payment on a particular lender's credit card, but with universal default, the lender will charge the rate if the customer defaults elsewhere.
Read more about this topic: Universal Default
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