The final new credit card rules enacted Aug. 22 aim to protect consumers from excessive late fees and unreasonable interest rate hikes. Thinkstock photo.

The final package of new credit card rules went into effect Sunday. The latest rules limit late payment fees and other penalties. This completes a major overhaul of the credit card industry that was set into motion by the Credit Card Accountability, Responsibility and Disclosure (CARD) Act of 2009. One of the newest federal laws cuts late payment fees to an average of $25. Over the past year as new credit card rules have been rolled out, credit card companies have been dramatically increasing interest rates. Another rule requires them to justify those increases to federal regulators.

New rules target late penalties and interest rate hikes

The newest credit card rules enacted Aug. 22 prohibit credit card companies from charging more than $25 for late payments, end the practice of charging customers for not using their cards, and order them to reconsider interest rate increases imposed starting from Jan, 1, 2009. CNN reports that credit card companies must cut interest rates if the reasons they claim for the increases no longer apply. Federal regulators will review those reasons and enforce compliance with the law. However, the new rules give banks wiggle room to hike penalty fees higher than $25 if a cardholder is habitually late with payments or if the credit card company can prove the high fee is justified to offset the  cost of late payments. Another new rule prohibits penalty fees from exceeding the minimum payment or the amount charged over the credit limit.

Credit card companies scheme to recoup lost billions

The latest round of new credit card rules could subtract $3 billion a year from credit card company bottom lines. The Wall Street Journal reports card companies have already been raising fees on balance transfers and cash advances, boosting charges for overseas transactions and charging higher annual fees. Because of the new rules, credit card companies are also expected to raise monthly minimum payments due, which would enable them to increase the late payment penalty fee. Banks accustomed to reaping huge profits from penalty fees aren’t letting go easily. A credit industry executive told the Journal that before the new credit card rules, credit card companies collected about $11.4 billion in late fees. That figure is expected to drop 29 percent to about $8.1 billion.

Credit card spending rises along with interest rates

While the new credit card rules have been giving consumers some protection from excessive late fees, credit card companies have been jacking up interest rates. Another CNN report said that in the second quarter card issuers raised interest rates on existing card holders to an average of 14.7 percent — up from 13.1 percent a year ago. The current spread between the average credit card interest rate and the prime rate is 11.45 percentage points — the widest it has been in 22 years, according to Synovate market research arm of Aegis Group. Synovate also said that credit card spending reached the second-highest level ever in the second quarter.

Changes in payment allocation from CARD Act

The CARD Act changed payment allocation rules by requiring that credit card companies apply consumers’ payments to the balance with the highest APR first, thereby paying down their most expensive debt as quickly as possible. However, in the final draft of the bill, the language was changed to say only payments above the minimum should be applied to the balance with the highest APR first. The minimum payment amount is still applied to the lowest APR first, which means extra costs for consumers and extra profits for credit card companies.

The Bill Was Changed Unfavorably In Committee

Senator Dodd introduced a bill on Feb. 11, 2009 (S.414) that proposed a payment allocation method that would apply the consumer’s entire payment to the balance with the highest APR first. However, during negotiations in the committee process, the committee reported an amended bill that changed the rule to only apply to payments above the minimum to the highest APR first.

How this affects consumers

The change in the language means a portion of everyone’s payments is allocated in an unfair manner. Even more troublesome, the 29 percent of Americans who can only afford to pay the minimum* have 100 percent of their payments allocated in a way that prevents them from paying down their most expensive debt. The people who need the most help are getting no benefit from the new rules meant to protect them.

How to avoid the pitfalls of payment allocation

Unless consumers are able to pay at least 15 percent of their credit card balance each month, they should only carry one type of balance on each credit card. Have a separate credit card for balance transfers and purchases – one credit card with a low interest rate on purchases and one with a low interest rate on balance transfers. Otherwise, just as in the old system, credit card companies will be able to delay consumers from paying down their credit card balances with the highest APRs.

* Source: FINRA National Survey – Financial Capability in the United States, December 2009

"Your eyes feel so very heavy. You will pay only the minimum balance on your credit card…"

We all know by now that making only the minimum payment on your credit card balance each month is a recipe for long-term debt. If that sounds appealing to you, then by all means, continue to fatten the pig. It loves the sloppy seconds (thirds… fourths…) of Joe Consumer. The best way around becoming a swine in such a situation is to pay your credit card balances in full.

But the minimum payment – the amount you must pay in order to keep ahead of accumulating interest – can be so enticing. It’s there in bold print on your bill, and would take so little out of your checking account. You’d be rid of it and have free reign to spend that money on something delicious. There it is, each and every month on your bill. It pops, and so many people have become conditioned to accept.

It’s Psychological Anchoring

It’s related to hypnotism and hypnotic conditioning, according to Neil Stewart of the University of Warwick. He writes in his Association for Psychological Science article “The Cost of Anchoring on Credit Card Minimum Repayments” that the minimum payment is a powerful suggestion that serves as a psychological anchor.

Think about it. Credit card debt is out of control. As a nation, Americans are on the hook for more than $2.5 trillion. Of that total, over $950 billion is tied up in credit cards. In the United Kingdom (from where Stewart hails), that’s nearly £175 billion with just over £55 billion on credit cards. Lenders are required by various agencies to collect at least a minimum payment each month, but you can be certain that if they could ask for less, they would. Compound interest is already a financial gale force; lack of basic regulation would prove to be a perfect storm.

Hypnotic Triggers Surround Us

This isn’t “hoodoo” or mysticism; it’s how our brains work. The power of suggestion is the cornerstone of advertising, politics/religion, sexuality and so many human affairs. Stewart suggests that anchoring in the financial sector involves using numbers to bias our judgments and decisions, even if the message is rather implausible. Call the minimum payment suggestion on a credit card statement a Jedi mind trick, if you will. You know they’re the droids you’re looking for, but the lure of the message is too hard to ignore. People should pay more, but the minimum payment suggestion is front and center like a hypnotic focal point.

Stewart’s Survey Opens Your Eyes

The author draws from a 248-member survey sample of credit card holders in the United Kingdom. They are split evenly by sex, and the ages range from 18 to 65. Of these, 196 participants carry credit card balances over. Ignoring the lure, 113 pay in full, while 83 made a smaller payment. Thirteen of these make the minimum repayment.

Perhaps Americans are more susceptible to financial hypnotism, or perhaps they are less educated than their British counterparts? I base this assertion on the marked difference in percentage of consumer credit debit being in credit cards between the nations.

So Stewart Spices it Up a Bit

Using data from a market research company, Stewart looks at a scenario where mock credit card statements were sent. Some included minimum payment information, while others did not. The outstanding balance remained the same. What he found is slightly different than what you might expect: those presented with a suggested minimum payment were not necessarily less likely to pay in full, but they definitely paid less when partial payments were made. Removing that hypnotic suggestion had a dramatic effect; mean repayment amount went up by 70 percent.

What Does This Mean for Real Credit Card Debt?

The author points out that if a consumer has a credit card debt of around $4,000 at a 20 percent APR, just a two percent reduction in the amount paid quadruples interest charges over the year. Including minimum payment numbers “roughly doubles interest charges,” Stewart found; it proves to be almost irresistible hypnotic conditioning. By the numbers, minimum payments amounting to $909 (about 23 percent of the $4,000 balance) would lead to $109 in interest charges. If the hypnotic trigger is not present (no minimum payment listed), repaying $1,603 (40 percent of the $4,000 balance) leads to a mere $49 in interest charges. “Anchoring on minimum-repayment information may be costly,” writes Stewart.

But Would Additional Warnings Help?

Not necessarily, and this is where financial education enters the picture. While additional warnings have been proposed, multiple sources Stewart engages have found that “warnings about the dangers of making only minimum repayments are likely to lead to disengagement rather than behavior adjustment.” In general, warning someone about anchoring and related hypnotic conditioning tends to prove ineffective; Americans’ general misunderstanding of compound interest certainly doesn’t help matters. However, Stewart does suggest that going one better than listing a minimum payment amount is necessary. Tables that show a variety of repayment scenarios and their impact would tend to help break the trance, so to speak. Credit card debt would lessen nationwide and make credit repair more likely. Remember, when it comes to hypnotic conditioning, nobody is being forced to do something against their will. It would be worth examining our own customs and motives when it comes to personal finance.

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(Photo: flickr.com)

Whenever you purchase something on credit, whether it’s a product or service, we all find out about the magic of revolving credit. Whether it’s a mortgage, student loan, car payment or credit card payment, you’re paying two different things if you don’t pay off the credit in full immediately: principle and interest. Pay off the former and you’re done. If you’re only paying the latter, your adventure has just begun. It may leave you with a bit more cash til payday in the short run, but you’ll end up having to pay much more in interest charges over the long haul. The reverse – which is the more healthy financial decision – means that while you may find yourself in need of a cash til payday loan once in a while, you’ll be saving much more money over the years.

Go above and beyond

The best way to quickly reduce the principle balance of a loan or line of revolving credit is to make payments that go beyond the minimum monthly payment. This is contrary to what most Americans do, however. Making the minimum payment each month may free up short-term cash for consumers, but it ends up costing much more in the long term, thanks to compounding interest.

But won’t that leave you broke?

Not if you budget properly. As everything is expensive these days, it’s understandable that people aren’t looking to part with additional funds each month. This is typically the kind of thinking that goes into making minimum payments each month on loans and credit. Yet the best way to protect your finances long-term is to pay more than the minimum each month. That way, both interest and principle are paid down more quickly.

Get a jump on your financial future

If getting a jump on those interest and principle balance payments is your goal, some planning is in order. The best way to do this is to look at your budget. Once you’ve taken care of the monthly essentials, see how much you can afford to pay above and beyond the monthly minimum. If you’re used to paying a minimum of, say, $900 per month on your mortgage, try $1,000. With credit cards, try to pay at least double the minimum if you can, as these cards typically bear high interest rates. The more you can pay now, the less you’ll be paying for months and years. Sure, use a cash til payday loan if you need in an emergency… the end result will be all the sweeter. I’ll even give you a magic button you can use to apply for one, in case you’re in that spot right now

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Like anything else, making radical changes – in this case to your budget – requires a significant adjustment period. Be patient and understand that unexpected expenses do happen. Be flexible; you will have to adjust on the fly. Once you get the hang of it, however, you’ll be well on your way to paying off your major purchases. Paying off a 30-year mortgage or a 48-month car loan before their time ends up costing you much less in the long run. Who wouldn’t want to do that?

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