Life on Financial Edge to Get Tougher
Deborah Falsman ran up $25,000 in credit card debt when interest rates were low, credit was easy and bankruptcy offered a simple escape hatch.
Now, the school health clerk is looking at payments that could rise by hundreds of dollars a month, thanks to new federal regulations aimed at helping Americans tame their soaring credit card debt.
“You think you can pay $500 or $600 a month and get it over with,” Falsman said of her credit card debt, which financed a remodeling project for her home in Denton, Texas. “But it never seems to work out that way.”
Consumer advocates are largely applauding the changes, which will take effect by Jan. 1, because they will save millions of credit card holders money by trimming what they pay in interest over time.
But for those living close to the financial edge, the combination of higher credit card minimums and rising consumer costs -- especially for gasoline -- could push them over the brink.
Bankruptcy offers one means of respite for these people, but starting Monday that option will be much tougher to pursue. New rules will make it harder for people to qualify for Chapter 7 liquidation bankruptcies, in which they surrender most assets to creditors in return for wiping out their debt.
“No one could imagine that all of these things would line up at exactly the same time,” said Bradford G. Stroh, chief executive of Freedom Financial Network, a debt-counseling firm based in Northern California. “But they are all hitting the American consumer in the fourth quarter of 2005. On the heels of that, the overleveraged consumer’s one parachute was Chapter 7 bankruptcy and that parachute is closing.”
Americans, who have seen energy costs climb 20.2% in the last year, are now finding out about higher minimum payments on their credit cards.
Most major credit card issuers have allowed customers to repay just 2% of their balances each month. For people with high interest rates, or who don’t pay their bills on time, the minimum often isn’t enough to pay down their debt.
For example, Citibank charges its higher risk cardholders about 29% a year, or 2.42% a month, in interest. Until recently, it allowed these cardholders to make minimum payments that amounted to only 2.08% of their balance each month, spokeswoman Janis Tarter said.
For a $10,000 balance, that would be a payment of $208. But that cardholder would accrue $242 a month in interest -- allowing the debt to grow by $34, even after paying the minimum.
In 2003, the four primary bank regulators -- the Federal Reserve, the Office of the Comptroller of the Currency, the Office of Thrift Supervision and the Federal Deposit Insurance Corp. -- agreed that these artificially low payments allowed consumer debt to snowball out of control. The regulators issued “joint guidance” demanding that monthly payments be set high enough that revolving balances would be repaid in 10 years.
Regulators later modified that dictum, requiring customers to pay at least 1% of the principal balance, plus all interest and fees that accrued that month. The rule takes effect Jan. 1, although some companies are already implementing it.
Under the new rule, a cardholder paying 29% interest on a $10,000 balance would be required to pay at least $342 a month -- or 64% more than under the old standard.
Minimum payments will vary from customer to customer, depending on the interest rate of the card, the size of the balance and other factors.
That makes it tough for people such as Falsman, who has roughly a dozen cards at varying interest rates, to figure out how much more she will have to pay. Falsman, who with her husband takes home about $7,500 a month, said she got hooked on several cards with low-cost introductory “teaser” rates.
Falsman said the couple must now pay about $500 a month to meet their minimum requirements. She said she already had gotten notices from several card companies saying her minimum payments would rise by 25% to 50%.
Financial planning experts say that a consumer with $25,000 in debt who is paying 29% interest could be required to pay at least $855 a month under the new formula -- $605 in monthly interest and $250 in principal.
Lisa Moore of Sacramento, who has $28,000 in debt on six credit cards, said so far only one of her lenders had sent a letter warning about a rise in the minimum payment. That card, which has a $6,500 balance, will require a $280 minimum payment starting next month, up from $180, she said.
“I’m glad I have a good job,” said Moore, 48, a library worker. “Otherwise I wouldn’t be able to make the payments.”
Not everyone will see a big hike, however, because the old minimum payment formula is sufficient to pay down debt for people who use cards with lower interest rates.
For example, a credit card holder who pays 10% interest and has $10,000 in debt would accrue about $83 a month in interest charges. Add on 1% of the principle, or $100, and the cardholder’s minimum payment would be $183. That’s less than the $200 -- 2% of the balance -- that credit card companies demanded under the old rules.
Consumer advocates consider the higher minimums to be better for individuals in the long run. The average household credit card balance is $9,205, according to credit research firm Cardweb.com, up from $8,940 in 2002. Nationally, outstanding credit card debt has ballooned from $443.49 billion in 1995 to $797.97 billion currently.
“Raising minimum payments makes sense because it allows consumers to pay off their debts faster and save thousands of dollars in interest,” said Joseph Ridout, who manages the consumer hotline at Consumer Action in San Francisco.
About 42% of all the U.S. 180 million credit card holders pay off their balances in full each month, 33% always pay more than the minimum and 15% don’t use the cards, according to a survey this summer by the American Bankers Assn.
It’s the remaining 10% of cardholders that lenders and consumer advocates are worried about, especially the roughly 4%, or 7 million people, who always pay just the minimum, the survey found. This group is also considered to be at a higher risk for filing bankruptcy -- something that will get tougher starting Monday.
The new law requires anyone attempting to file a Chapter 7 bankruptcy to go through credit counseling and provide the bankruptcy court with a detailed financial statement.
If the debtor’s income is above a certain amount, the individual will be forced into a Chapter 11 “reorganization” bankruptcy, which requires him or her to make payments to creditors for five years.
No one is quite sure how many people will be barred from Chapter 7 bankruptcies under the new law, but some indebted consumers aren’t taking any chances.
Chapter 7 bankruptcy filings rose roughly 18% in the three months ended Sept. 30 compared with the same period last year, and the pace of filings may be picking up. Pasadena attorney Charles Brash said he had filed more bankruptcies in the last few days than he filed in all of last year.
“Last year, we were able to keep people out of bankruptcy because interest rates were so low we could help them refinance their houses, so they could avoid it,” Brash said. Now, he says he’s got his office staff working late nights and weekends to keep up.
“We’ve filed 10 bankruptcies in just the last two days,” he said Monday.
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Largest creditors (in billions)
U.S. credit card issuers, ranked by debt outstanding as of June 30. BofA will be the largest after merging with MBNA
JPMorgan Chase: $136.60
American Express: $65.40
Bank of America: $62.50
Capital One: $50.10
Washington Mutual: $18.60
Wells Fargo: $15.40
Source: Nilson Report