Credit & Money Management
Avoid the Minimum Payment Trap
The longer you drag out repayment, the more interest you'll pay.
By Ronaleen Roha
January 22, 2003
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I got a bit miffed when I opened my MBNA credit card statement this month. The "new balance total," which I typically pay every month, was missing from its prominent space at the top of my bill. All that remained was the minimum payment amount. I felt as if the nation's number-two credit card issuer was trying to trick me into carrying a balance.
The company's true intentions are unknown, however. Repeated attempts to contact an MBNA spokesman were unsuccessful. (UPDATE)
I eventually found my new balance total. (I knew it had to be somewhere on the bill; it's required by federal law.) It was in the "summary of transactions" section at the bottom of the statement in smaller type.
The wrong message
Credit card issuers "keep consumers confused so they can't figure things out," says Robert McKinley, chief executive of CardWeb.com, a firm that monitors the credit card industry. The idea being if you can't find your interest rate or the extra charges you're paying, you're more likely to keep paying them.
But Steve Rhode, president and founder of Myvesta, a nonprofit financial management organization, says consumers might actually benefit from these types of statement changes. "When the new balance was at the top of the statement, it never gave you any incentive to see what else they were charging you for." By putting the balance next to the interest and other finance charges customers can get a better understanding of their accounts, he argues. However, about 25% of cardholders don't even read their statements every month, a recent Myvesta survey reveals.
Confusion aside, playing up the minimum balance, and playing down the monthly pay-off amount "encourages paying the minimum amount," says Stuart Rossman, director of litigation for the National Consumer Law Center, in Boston.
When you need a little breathing room in your budget, mailing in the least amount possible for a month or two won't kill you. But falling into the habit of paying the minimum every month "increases your exposure and ratchets up the amount you will pay down the road," Rossman says. According to McKinley, about one-quarter of all cardholders fall into this trap.
The real cost of paying the minimum
It's pretty obvious why banks would want you to pay the minimum (it's the same reason why minimum payments keep shrinking): The longer you drag out repayment, the more interest they can collect. How much more more? If your balance is $1,500, your annual percentage rate is 16% and the card issuer sets the minimum at 2% of the outstanding balance ($30), you'll spend nearly $2,330 on interest and stretch your bills out for more than 20 years. And that doesn't even take into consideration additional charges to the account, late fees or other charges along the way.
However, if you increase your payments to $100 a month, the payment period drops to 17 months and the interest falls to $184.79.
Crunch your own numbers to learn the true cost of paying the minimum.
Minimum payments used to be around 4%, but today many credit card issuers set them at or below 2%. Mine is less than 1%. Many banks set the minimum payment so low that it doesn't cover the interest or added fees (such as late payment penalties, which can hit $35 or $40, or fees for spending over your credit limit). So even though some people pay the minimum every month, their balance grows.
Federal banking regulators have just issued a new set of guidelines designed to prevent this "negative amortization." The rules, which will apply to all banks, say that credit card issuers must set the minimum monthly payment at an amount that will let the cardholder pay off the debt in a "reasonable period of time."
This means that for some cardholders the monthly minimum payment will increase. (Banks also have the choice of lowering fees, but don't count on it.) This might strain the budgets of those who regularly pay the minimum due, but on the other hand it will free them debt sooner.
Other card tricks
Some other tips to help you pay off those credit cards include:
- Don't wait to the last minute. Many issuers now use what McKinley calls a "hair-trigger" system for late fees. In some cases, you could get hit with a $35 to $40 penalty if the payment is just a few hours late.
- Talk back. If you are a customer who carries a balance and pays on time, ask for a lower interest rate and removal of any fees. Tell the issuer about the 0% offers from other issuers and your interest in switching. "It's part of the game," McKinley says. The banks "are not trying to change your behavior with the fees. They are just trying to get a few more nickels and dimes from you." If the bank won't bargain, shop for a new card.
- Check your statement. Reviewing your statement every month could turn up errors, such as a double charge for the same item, or signs of unauthorized use.
| Update |
|
MBNA announced on January 24 that it will be returning to its original billing format. Two days after this column appeared, James Donahue, spokesperson for MBNA, said moving the new-balance total to the bottom of the statement was an attempt to improve the security of its cardholders. MBNA sometimes asks cardholders for their new-balance total as part of the process for verifying a caller's identity, he said. "Any speculation that we [moved the new balance total] for any reason other than what I said are just that, speculation," he said. "Unfortunately," he said, "this particular measure annoyed some customers who told us that they liked having that information on the remittance coupon." The change barely survived one billing cycle. While some of the unpopular statements are still in the pipeline, the more familiar forms should arrive in mailboxes next month. |
