Paying The Credit Piper

Consumers with credit cards will shoulder higher minimum payments, starting this summer. How will this affect you and what can you do about it? Financial adviser Ray Martin explains as part of his regular appearance on The Early Show.

Right now, credit card issuers are rolling out their response to guidance issued in January 2003 by a federal agency called the Office of the Comptroller of the Currency. This guidance spelled out prudent practices for banks, thrifts and other institutions engaged in credit card lending.

Of particular concern was the general easing of minimum payment requirements found in numerous credit cards in recent years. For an increasing number of credit cards, the minimum payment requirements not only did not require any principal to be paid but allowed some interest to go unpaid as well, allowing unwary consumers to make minimum payments without ever reducing their debt.

The guidance made it clear that credit card lenders should instead set minimum payments that, if made, will ensure that credit card balances are paid down over a reasonable period of time, so as to avoid prolonged unpaid credit card debt by card holders.

This summer, five of the top ten credit card issuers (including Bank of America, Chase, Citibank, Discover and Providian) are rolling out changes to the minimum payment requirements for their credit cards and by next year, most card issuers will have made similar changes.

It's estimated that 40 percent of all credit holders pay their credit card balances in full each month, so this change is not likely to affect them. But for the rest of credit card holders who do not pay off their balances, some of whom make only minimum payments each month, this change is a big deal.

Typically, minimum payments have been set at an amount equal to 2 percent of the current months balance. It is widely advised to avoid paying just the minimum payment on credit card debt because when doing so, it can take more than 30 years to pay off a balance. But the minimum payment provides relief in the form of a small monthly payment that can be made when cash flow is lean, while still keeping the credit card account current.

Since banks and card issuers are left to define a "reasonable minimum payment," they are adopting a variety of formulas to comply with the guidelines.

For example, Bank of America now requires card holders to pay all fees, interest and at least $10 toward the balance. Citibank requires card holders to pay a minimum of all fees and interest, plus 1 percent of the balance each month.

Some card issuers have doubled minimum payments (from 2 percent of the current balance to 4 percent), and others have made no changes at all. MBNA Corp, the credit card issuer to be acquired by Bank of America, rolled out their higher minimum payments to new customers in July, and they are rolling out these to pre-existing customers later this year in October.

Consumer advocates say that this is both good and bad news for credit card holders.This is good news for consumers, because higher minimum payments can dramatically reduce the amount of time and interest that is required to pay off credit card debt.

For example, assume you carry a $10,000 balance on a credit card that charges 13 percent interest (the national average is approximately $9,300 and 15 percent). If you pay the minimum payment of 2 percent of the balance each month (which starts off at $200 each month), it will take you about 33 years to pay off the balance, and you would have paid interest totaling about $11,450.

With a higher minimum payment of 4 percent, the initial monthly payment would double to become $400. When you pay the higher minimum payment, it will take only 13 years to pay off the balance, with total interest paid of about $3,664. In this example, with the higher minimum payment, you would save more than $7,700 in interest charges and pay off the balance 20 years sooner!

This is bad news for some consumers because the minimum payments for their credit card debt can double. For consumers who are already struggling to make minimum payments on their credit cards, these higher minimum payments come at a time of rising energy prices and mortgage payments and when bankruptcy protection laws are getting tougher. Consumers who have high credit card balances, balances on multiple cards or whose cash flow is lean are apt to feel the most pain from increased minimum payment standards.

Industry experts say this is also not good for the card issuers. Credit card companies will collect less income from interest charges paid by their credit card customers. They also say that increased minimum payment standards will drive more marginal borrowers into default, requiring credit card issuers to absorb increased charge-offs for accounts that go unpaid.

Credit card issuers are required to notify customers by sending a legal notice of change in their terms at least 15 days before any change is applicable. It's a safe bet that these legal notices will go unread by most card holders.

What should all credit card holders do now? Here are a few suggestions:

• Call your credit card issuer and inquire what the new minimum payment formula will be and when it applies to your account. Also read your monthly credit card statements carefully for any notice of changes in payment terms.
• If you schedule automatic payments from a bank account to your credit card account, review to ensure that the scheduled payments will be sufficient to cover the new, higher minimum payment.
• Shop for a credit card that offers a lower interest rate at www.bankrate.com or www.cardratings.com. If you get a card with a lower rate, the minimum payment should also be lower.
• Call your credit card company and ask for a lower interest rate on your card – you are more likely to get a lower rate if you are a loyal customer with a long history of making payments on time.
• Avoid making any new charges on a credit card account you are trying to pay down.