The New Revolving Credit Regulations  

“You want 21 percent without risk?  Pay off your credit cards.”

                                  --Andrew Tobias

As with every New Year, there are a concomitant number of new laws and regulations.  One, that may surprise a number of people this year, is that the minimum monthly payments on revolving credit (credit cards) have tripled.  The new banking regulation is designed to tighten credit and combat inflationary pressures facilitated by credit card issuers.

Heretofore, the minimum payment one could make on one’s credit card balances was in the range of 2-5% of the outstanding balance. The insidious aspect of compound interest is that at 19.8% (or more) per annum an individual making the minimum monthly payment of say $16.58 with a balance of $1000 would need 27 years to retire this debt, and that’s if the individual incurred no new charges.  In years past, this was a cash cow for many credit card companies because as is evidenced by the example given all but a small portion of these payments went to servicing the debt (interest).

With gas prices increasing, bankruptcy laws tightening and interest rates rising…it’s really no wonder that the average default rate on credit cards is climbing.  According to the American Bankers Association, nearly 5% of credit card accounts had payments that were 30 days or more past due last year.  Missing payments on credit cards can be more costly than you think.  The late payment will result in the creditor imposing a late fee—on average $27—and more importantly, they will bump up the future interest rate you are charged.  And get this…being late on one credit card may trigger the other creditors to increase the interest rates as well, even if you’ve made the other payments on time.  This is known as the “universal default” clause, and is disclosed in the infamous fine print on credit card agreements.  Credit card companies can monitor your financial activities and if they feel that the risk of being repaid is high, they have the right to increase your rate.  The state in which the creditor is located may have an impact on the interest rate too—take a look at your credit card statements to see where they are based.  Notice South Dakota or Delaware?  They are among several states without usury laws, meaning there is no limit on the interest rate charged.  The APR on cash advances can be truly staggering—in the range of 35 to50%

So, How Do You Know If You Are In Too Deep?

If you always make the minimum payment, are late on other payments or borrow from one creditor to pay another, you are overextended. You are certainly not alone, though.  The latest statistics show Americans owe $798 billion on credit cards.  Broken down, the average credit card liability per household was $9,312 in 2004 (that amount has increased 116% in the past ten years) and approximately 35 million Americans pay only the minimum payment required each month.

So, What Is One To Do?

Start by keeping your card balances well below the maximum credit limit…or if you can keep from charging it up ask your creditor if you can have a higher limit.  Keeping your balance below your maximum limit will help improve your credit score.  Next, make a list with the name of the creditor, the balance, the minimum payment due, and the interest rate.  Review the list and pay off as many small accounts as possible.  Then, make the minimum payments on all credit cards except the highest interest rate credit card.  Once the first credit card is paid in full, continue this process until all credit cards are paid in full.

Another measure you might consider once you have your credit card payments under control is converting some of your credit cards to debit cards.  With debit cards the actual amount of the purchase is deducted from your bank balance.  This has two consequences it forces you to wean yourself off of minimum payments and you’ll be less inclined to   use your credit card to purchase a $30 item (like say a tank of gas) with a credit card when you realize that if you made the minimum payments that tank of gas will have cost you $36 by year’s end.

Debt Consolidation Loans—Another Way to Go

For people strapped with payments on numerous revolving and installment debt accounts a home equity debt consolidation loan or refinance may be a real life saver.  People need to remember they pay their mortgages with dollars not interest rates.  Lower interest rates usually translate into lower mortgage payments, but not always.  Such is often the case where a refinance involves debt consolidation.  As an example, a couple may benefit greatly if they have a current mortgage balance of $200,000 @ 6.5% and a $100,000 in credit card and installment debt.  Their monthly payments might total $3000 per month.  But, if they were to refinance their mortgage into a $300,000 mortgage ($200,000 + $100,000 cash out) @ 7.5% (a full 1% higher than what they now have) their payment would be $2097 per month, thereby saving them $903 per month.  The monthly savings would actually be even greater, because now all the interest that they would normally pay on their credit card and installment debt is now tax deductible with their new home equity loan.  Reducing a borrower’s cash outflows from 50% to a 40% of their income effectively puts ten cents of each dollar back into the borrower's pocket every month.  More importantly, it often saves a borrower's home and credit. 

Copyright © 2020 Rod Haase.  All rights reserved.