We'll Have to Pay More. Good!

By Michelle Singletary
Sunday, September 25, 2005

There is a lot of misinformation being circulated about an industry-wide change in credit card minimum payments.

One reader from Atlanta asked: "I heard recently that when the new bankruptcy law goes into effect in October, our credit card minimum payments will double. Is there any truth to this rumor?"

I answered this reader's question in my weekly online newsletter for http://www.washingtonpost.com/ . However, this is a frustrating financial myth that keeps popping up. Specifically, people are asking me if it's true that minimum credit card payments will jump to a mandatory 4 percent.

The fact is, by early next year many credit card users will see their minimum required payments go up. Some have seen a bump already. But the hike has nothing to do with the new Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, which will take effect Oct. 17.

Companies are increasing minimum payments as a result of new credit card lending guidelines issued by the Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corporation, the Office of the Comptroller of the Currency and the Office of Thrift Supervision.

In 2003, the agencies issued the guidelines to banks and thrifts as a result of what they considered inappropriate credit card marketing and account management practices.

For years the minimum payment on credit balances has been about 2 percent. With such a low requirement, some people find they don't make much of a dent in their debt principal. Regulators told lenders they had become concerned that competitive pressures and a desire for issuers to "preserve outstanding balances" had contributed to an easing of minimum payment requirements in recent years. The result, of course, is that it takes years for consumers to pay down their outstanding debt.

"We thought that was something that wasn't right," said Dean DeBuck, a spokesman for the Office of the Comptroller. "The minimum payment should have some effect on reducing the debt."

Here's what could happen if you pay the average 2 percent minimum payment on a $10,000 credit card debt. At 18 percent interest, it will take you about 58 years to be rid of your debt. In that time, you will pay $28,930.64 in interest, according to a calculator at Bankrate.com that shows people the true cost of making minimum payments.

In the 2003 guidelines, regulators did not specifically require that minimum payments rise to 4 percent. Instead, they recommended that minimum payments be set so people could pay off their balances in a "reasonable" amount of time. It seems that the word "reasonable" caused some confusion. So the regulators issued a clarification that the minimum payment must cover interest, fees and at least 1 percent of the outstanding balance each month, DeBuck said.

"Because banks were having trouble deciding what was reasonable, we have gravitated toward 1 percent of the principal," DeBuck said. "This is not a hard and fast rule, and banks may establish other payment amounts."

Many cardholders have already begun to see the change. For example, MBNA Corp.'s old policy required consumers to pay their finance charges, fees (if any) plus $15 or 2.25 percent of their balance, whichever was less. The company's new policy requires cardholders to pay finance charges, fees and 1 percent of their balance. For those who were customers before July 1, the change applies beginning with their January 2006 payment. For those who got a card after July 1, the new formula was applied immediately, according to MBNA spokesman Jim Donahue.

Donahue said the policy change won't affect many of MBNA's customers.

"More than 95 percent of MBNA customers always pay more than the minimum every month," Donahue said. "Of those who do pay the minimum, very few do so for more than two months in a row."

Your minimum payment will depend on your credit issuer. Although some people have seen their minimum payment rise to as much as 4 percent, other companies are strictly following the interagency guideline.

"For many consumers who have traditionally made only minimum payments on their credit card debt, a debt-free life is a near-impossible dream," said Robert Barrett, president and chief executive of InCharge Institute, a nonprofit organization specializing in personal finance education and credit counseling. "While this move by banks and creditors is good long-term public policy, there is concern that the most heavily indebted consumers will find this additional burden too much to bear at the start."

Nonetheless, Barrett and others who work in the credit-counseling field are applauding the increase in minimum payments.

And so am I. I understand there will be times when folks can afford to make only the minimum payment. But credit card debt is an insidious thing. People intend to pay more each month, but life gets in the way and next thing they know they have a bill that will take decades to pay off.

This move by the bank and thrift regulators to boost minimum payments is long overdue, just like many people's credit card accounts.

Researcher Lorraine Denis-Cooper contributed to this column.

· On the air: Michelle Singletary discusses personal finance Tuesdays on NPR's "Day to Day" program and online athttp://www.npr.org.

· By mail: Readers can write to her at The Washington Post, 1150 15th St. NW, Washington, D.C. 20071.

· By e-mail:singletarym@washpost.com.

Comments and questions are welcome, but because of the volume of mail, personal responses are not always possible. Please note that comments or questions may be used in a future column, with the writer's name, unless a specific request to do otherwise is indicated.

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