Your Finish Rich Plan - A Personal Finance Blog

Archive for March, 2008

Saturday’s New York Times Editorial was dedicated to credit card debt and the “tricks and traps” used by credit card companies to not only keep their customers in debt, but also to extract every last possible dollar from them. According to the piece, “[…] an increasing number of people are defaulting because of the “tricks and traps” — soaring interest rates and hidden fees — in the credit card business”. Although I do believe that we ultimately should be held responsible for our actions, I couldn’t agree more with this statement. A little research on my part unearthed the following details on the aforementioned tricks and traps:

.

• Universal Default Policy. 45% of the credit card companies out there have universal default policies. Such policies make it possible for creditors to monitor your credit report, looking for late payments to other creditors, and increasing your interest rates should you default on financial commitments with other parties. Under universal default policies, credit card companies can raise your rates if you go over your credit limit on other credit cards. They can also decide you are carrying too much debt in general, and by declaring you as a risky borrower, can raise your rates. Other risk factors listed in typical universal default policies are using over half of your line of credit for a specific credit card, having too much credit available or too many trade lines open, making what they consider to be too many credit inquiries on your credit report, or taking on a new mortgage or car loan.
• Arbitrary rate hikes. Chances are, the contract you have with your credit card company gives it the right to change the terms of the deal - including your interest rate - at any time and for any reason with just a 15-days advance written notice. One bank contract states baldly (or boldly, you be the judge!): “We reserve the right to change the terms at any time for any reason.”
• Due dates. Another practice is that of due dates that suddenly shift — forward — so that an unwary consumer pays late. The credit card companies are counting on you to not pay attention and get caught, and then you get hit with a late fee, as well as a punitive increase in your interest rate.
• Late fees. Many credit card companies now use a tiered penalty system that is based on your monthly balance, so the more you owe, the bigger the penalty if your payment is late. In 1994, the average late fee was $12.55. By 2004, the average credit card late fee had risen to $32.65. This Washington Post article relates the story of a woman who “[…] tried for six years to pay off a $1,900 balance on her Discover card, sending the credit company a total of $3,492 in monthly payments from 1997 to 2003. Yet her balance grew to $5,564.28, even though […] she never used the card to buy anything more. Of that total, over-limit penalty fees alone were $1,158.”
• Cash APRs. 75% of credit cards have a higher APR for cash advances taken with the card. The average cash advance rate on these cards is 20.23%. On cash advances, the interest begins to accrue immediately, even if you do not carry a balance. And in most cases you can forget about paying off the cash advance until you pay off the debt that carries the lower APR! This wasn’t mentioned in the NY Times article but I felt like it had to be stressed.

It seems Congress is finally to take the bull by its horns. The Credit Cardholders’ Bill of Rights was introduced by Representative Carolyn Maloney, Democrat of New York, and constitutes an excellent first step. Here are the points that most appealed to me: (For a summary of the bill’s provisions, click here)

• Ban of collection of interest on amounts already paid. Some credit cards allow the cardholder to be charged a higher interest rate on balances incurred before a rate increase went into effect. On the bill, the ban would “prevent card companies from retroactively increasing interest rates on the existing balance of a cardholder in good standing for reasons unrelated to the cardholder’s behavior with that card”. I think they should go one step further and extend that ban to balance transfers, where the card issuer offers a low, introductory “teaser” interest rate to new customers. However, this low introductory rate often applies for only a short period of time. Once the introductory offer period has expired, a higher interest rate will apply retroactively, unless the balance on the card has been paid off. No matter how much of the balance you have paid off, you will be hit with a finance charge based on the ENTIRE OWED AMOUNT from the time you signed up for the card.
• Cardholders who pay on time should not be penalized. Prohibits card companies from charging interest on debt that is paid on time during a grace period. This prevents the so-called “double-cycle billing” practice. Two-cycle billing calculates interest based on two billing cycles, instead of the more common method of determining interest only on the immediate billing cycle. Two-cycle billing penalizes customers who carry a balance, even if only on occasion. For example, a cardholder begins a billing cycle with a zero balance, charges $1000 and makes an on-time payment of $900. Under one-cycle billing, the cardholder will pay interest only on the unpaid portion of the bill, or $100. However, under double-cycle billing, the cardholder will be charged interest on the full $1000 from the date of purchase, rather than on the $100 still owed. In other words, the cardholder will pay interest on the portion of the bill that was already paid. And even if the cardholder pays off the balance in full in the next billing cycle, interest will still be charged for the time between the close of the billing cycle and the date payment is received.
• Protection from due date gimmicks. The bill of rights would also require the credit card companies to give you a 45-days advance notice in writing about any rate changes. Then you would have three billing cycles to say ‘no’ to the new terms. This would give you time to look for another card.
• Ability to cancel cards if rates suddenly skyrocket and pay your existing balance at the existing interest rate and repayment schedule if you get hit with an interest rate hike. This one is pretty much self-explanatory, although I expect a lot of the debate to center on exactly how much of an increase triggers the ability to cancel.

Congresswoman Maloney, states: “I believe that in recent years, the playing field between credit card companies and credit cardholders has become very one-sided […] A credit card agreement is supposed to be a contract, but what good is a contract when only one party has any power to make decisions?”

Amen to that! “Today’s credit card users could use the protection.” says the NY Times.

Personal Finance

Technorati Tags: bad credit, credit score, fico, good credit, save money