In a recent column for the NY Times, Freakonomics authors Stephen Dubner and Steven Levitt explained the genius behind the concept of low credit card minimum payments. When studied by academics, test subjects who selected their own minimum payments often paid far more than monthly bank statements required. For many years, credit card issuers have used tricks like these to prolong credit card debt repayments, earning billions of dollars in interest along the way.
Regulators have kept an eye on minimum payments on credit cards for years, with guidance in 2006 from the Office of the Comptroller of the Currency (OCC) to raise minimum payments for many banks. Many credit card issuers responsded by changing their minimum payments to 1% of the principal balance, plus any interest charges and fees. At the time, lawmakers expressed hopes that new rules would prevent the strung-out accounts described by Dubner and Levitt. Likewise, representatives from the banking indusrty complained during Congressional hearings that higher mandatory credit card payments unfairly limited lenders' abilities to generate profits. The world didn't end, and American cardholders grew accustomed to paying off more of their balances during each cycle.
Chase Voluntarily Rises Minimum Credit Card Payments
Recently, at least one major card issuer has exceeded government expectations by requiring some customers to pay an eye-popping 5% of their total balances each month. Chase will be raising minimum payments to 5% on some accounts starting this month. Some media outlets have portrayed the actions of Chase as anti-consumer. In an economy where household cash flow has become more important than ever, surrendering 5% of an outstanding account balance can feel burdensome. However, heightened monthly minimums offer "tough love" that can actually elevate our country's financial climate in three ways:
? Consumers preserve more of their capital
? Banks recapitalize their loans more quickly, limiting risk.
? Consumers are less likely to pay other fees, such as over limit fees, since debt repayment is accelerated.
Banks Put Profit at Risk, Yet Consumer Advocates Cry Foul
From a profit standpoint, banks have everything to lose by adopting this strategy. Card issuers must adapt their screening process to find only those prospective customers who can afford substantially larger monthly payments. Marketers must find ways to encourage more frequent card use to offset lost interest earnings with higher credit card interchange fees. And banks find themselves in the unlikely position of making decisions in the best interests of their customers instead of for the benefit of a bigger bottom line.
Yet, some consumers and consumer advocates still don't see it that way, especially working Americans who live paycheck to paycheck. Using a credit card to weather a sudden illness or a job loss has become all too common. Asking customers to surrender more from their paychecks or benefits can seem unfair and cruel. And economists worry that paying off too much of our credit card debts during a recession can delay a much-needed recovery driven by spending.
Still, higher minimum credit card payments could be exactly the kind of tough medicine we need to help accelerate our country's long-term savings. Some consumers still see the change as "retaliation" by credit cardissuers against recent industry reforms and that is unfortunate. Credit card issuers are simply trying to limit their risk and we as consumers are actually benefiting from this in the long run.
Going forward, banks must work even harder to help educate consumers about credit for higher minimum payments to become widely accepted and understood. And consumer advocates, regulators, legislators and members of the media need to look at both sides of the coin.
Just my two cents -- I would certainly welcome your thoughts in our active credit forum!