Consumers struggling each month to make the minimum payment on credit cards, brace yourself.
Many card issuers, under pressure from federal regulators, will be raising those limits by the end of the year, if they haven't already done so. How much depends on the lender, because each will devise its own policy. But some banking experts predict that consumers could see minimum payments nearly double.
This is a step in the right direction, say consumer advocates who have long criticized payment policies that make it easy for consumers to pile on debt. But they acknowledge that the change will be bitter medicine for the most vulnerable of cardholders.
"The bad news is there are an awful lot of consumers right now who are having trouble just keeping up with the minimum," said Gerri Detweiler, author of the Ultimate Credit Handbook and founder of DebtConsolidationRX.com. "This definitely will put them over the edge."
Back in the late 1980s, the standard monthly minimum payment was 4 percent of the balance, Detweiler said. By the 1990s, banks figured out they could boost profits by lowering minimum payments to about 2 percent, which encouraged people to borrow more, experts said.
"You didn't see many in the mid-'80s with over $10,000 in debt," said Robert Manning, a finance professor at the Rochester Institute of Technology and author of Credit Card Nation.
Today, Manning said, he sees consumers with $25,000 to $35,000 in card debt, almost as much as their annual income.
Minimum payments generally have worked like this: Consumers pay about 2 percent of their balance, and that money first goes toward paying off fees, then interest, and--only if there's money left--toward reducing principal, Detweiler said.
By paying the minimum on a card with a 14 percent annual interest rate, it would take a cardholder more than 29 years and $6,555 in finance charges to pay off a $5,000 balance.
Sometimes, though, the minimum isn't enough to cover fees and interest, and the extra amount due is added to principal. That means consumers can make monthly payments and still see balances rising.
This caught the attention of regulators, who were concerned about consumers falling deep into debt and the impact that would have on the soundness of banks' creditcard portfolios.
In January 2003, the Office of the Comptroller of the Currency and other regulators advised banks to change their policies--if necessary--so that consumers pay off some principal each month as well as fees and interest.
Some issuers won't be changing. Capital One, for example, said its minimum will remain at 3 percent of the balance or $15, whichever is higher.
Others, though, have raised minimums, or expect to do so by the end of the year.
Bank of America used to calculate minimum payments under two formulas. Customers paid the lesser amount, which could be as low as $10. About a year ago, the lender switched to a $10 minimum on top of any fees and finance charges.
Citigroup is phasing in changes this year. Under its old formula, the minimum was slightly over 2 percent of the balance, although sometimes that wasn't enough to cover interest and fees. Under the new policy, consumers will pay fees and interest plus 1 percent of the balance, which will go toward reducing the principal.
Lenders say the vast majority of cardholders pay more than the minimum each month, so the changes will have little or no impact.
Some lenders also are still tweaking their policies to avoid pushing vulnerable consumers "over the brink," Manning said. And Greg McBride, senior analyst at Bankrate.com, said some banks already are boosting reserves to cover losses if customers can't make the higher payments.
If you're having difficulty meeting minimum payments, now is the time to try to get debt under control. In many cases, the new minimums will kick in around the same time the new bankruptcy law takes effect, in mid-October. That will make it harder for consumers to wipe out debt.
In addition, interest rates likely will be headed up over the next year, making card payments even more onerous, Manning said.
One of the first steps is to look for a lower-rate card or negotiate with your lender to reduce your rate, some experts said. The less you pay in interest, the more money you can put toward principal.
Go on a strict financial diet, said Robert Pagliarini, a Los Angeles financial planner and author of an online newsletter, SixStepsOrLess.com. "It's going to be painful in the short-term, but it's critical to long-term financial health," he said.
Seek ways to cut expenses and free up cash to pay card debt, he said. If that's not an option, look for ways to increase your income, he said. Ask for a raise. Offer to work overtime. Or get a part-time job.
Cut up credit cards so there's no temptation to use them, Pagliarini said.
Seek outside help, if necessary. "If you are having difficulty in managing your payments on time and juggling your other obligations, contact the issuer to try to make other arrangements or seek credit counseling," McBride said.
It's never a good practice to regularly only pay the minimum. And even though those limits are rising, consumers should still try to pay more.
Jay Hancock is a columnist for The Baltimore Sun, a Tribune Co. newspaper.
This story ran on LA Times on July 17, 2005.