Credit Card Traps and PowerPay Debt Reduction Program

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Credit Card Traps and PowerPay Debt Reduction
Program
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The Other Side of Compound Interest

• When you invest, compound interest is your friend
  -)

• When you pay interest on credit cards and loans,
  compound interest is your enemy -(

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Background Statistics

• More than 60 of credit card users carry balances
• Only 37.4 were convenience users in 03/04
• In 03/04, average credit card debt (including
  those with no balances!) was 8,000
• Those with balance average about 12,000
• The average household pays 1,000 in interest
  and fees annually
• The typical cardholder has 7-10 credit cards
• Bankruptcy rate continues to soar!

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What is the Worst Credit Card Trap of All?

• Teaser rates?
• Default rates (penalty APRs)?
• Late fees?
• Over-the-limit fees?
• Minimum payments?

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Credit Card Minimum Payments!
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Case Example

• Outstanding balance 2,000
• Interest rate 18
• Minimum monthly payment 2 of balance, no
  payment less than 15
• Interest cost over loan period 4,183
• Paying off the debt will take 23 years!!!

Source Credit Card Smarts calculator, Advantage
Publications
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Credit Card Payback1,000 Balance (20 Minimum
Payment)
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Low Minimum Payments.
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Factors Affecting Finance Charges

• APR (interest rate)
• Grace Period
• Balance calculation method
• Result significant effect on the cost of credit.

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Average Daily Balance Method

• Most common computation method used
• Outstanding balances added daily
• Total is divided by days in cycle
• New purchases may or may not be added
• Interest assessed each day at daily rate

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Average Daily Balance- Example
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The Two-Cycle Average Daily Balance Method

• ADB of current cycle is calculated
• ADB of previous cycle is calculated
• New balance sum of ADBs for two cycles
• May or may not include new purchases
• The least consumer-friendly method

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How to Save Money

• Pay bill in full to avoid finance charges
• If carrying a balance, shop for a lower interest
  rate
• If paying in full, shop for a card with a grace
  period and no annual fee
• Pay bill immediately or ASAP to avoid late fee
  (short turnaround time)

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Transaction Fees

• Fee charged each time a credit card is used
• Example 50 cents per charge
• Most common transaction fees are for
• Cash advances
• Balance transfers

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Cash Advance Fees

• Cash loans from credit card account instead of
  making a purchase from a merchant
• Credit cards charge fees for this service
• Cash advance fee from date of an advance
• Fees range from 1 to 5 of amount transferred
• Most cards have minimum cash advance fees
• Average minimum about 5

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Example of Cash Advance

• 500 cash advance
• 2.5 transaction fee (12.50)
• 18 APR
• Pay back after 25 days
• 12.50 fee 6.00 interest
• Effective interest rate of 44

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Balance Transfer Fees

• Company B pays balance with Company A
• Balance on Company B credit card
• Transfer done to get a lower APR
• Balance transfers may have transaction fees

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Tiered Pricing

• Range of possible APRs quoted
• APR determined by applicants credit score
• Lower scores pay higher APRs
• APR unknown until consumer gets card

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Skip-A-Month Offers

• Often used around the holiday season
• Cardholders can skip payment without penalty
• Interest continues to accrue
• Increases total cost of borrowing

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Teaser (Introductory) Rates

• Low initial interest rates
• Entice people to apply for credit card
• May only apply to balance transfers, not new
  purchases (read the fine print!)
• Check disclosure box for non-promotional APR

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Punitive Policies

• Inactivity fees for
• not using credit card within specified period
• using card less than specified number of times
• charging less than a certain dollar amount
• Penalty for paying less bill in full on time
• Target convenience users who do not pay
  interest

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Credit Card Tips

• Read disclosure charts carefully
• Shop around before accepting a credit card
• Dont use credit to extend your income
• Pay bills in full, if possible
• If not, pay as much of balance as possible
• Avoid using full credit line
• Protect your account numbers

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More Credit Card Tips

• Match credit cards to bill-paying habits
• Ask creditors to make concessions
• drop annual fee
• reduce interest rate (APR)
• Limit your debt level
• Read mail from card issuers
• Complain if you are unfairly penalized

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Cards With Perks

• Examples cash back, product discounts, and
  frequent flyer miles
• Best for cardholders who
• charge a lot
• pay bills in full
• Revolving borrowers interest and fees may
  exceed benefit gained

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Online Credit Card Resources

• www.truthaboutcredit.org
• Information and balance payment calculator
• www.creditalk.com
• User-friendly credit card information
• www.bog.frb.fed.us/pubs/shop
• Semi-annual credit card survey results
• www.consumer-action.org
• Annual credit card survey results

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PowerPay Requirements

• Stop borrowing or charging until all debts in the
  PowerPay calculation are repaid
• Make the same dollar amount payment each month
  until all debts are repaid
• The money gets reallocated to creditors
  differently every time a creditor gets repaid
• See www.powerpay.org for details

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Required Information For a PowerPay Analysis

• Name of each creditor
• Balance owed
• Monthly payment (minimum or above)
• APR (interest rate)

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More About PowerPay

• Three repayment options
• Highest interest rate first (in sequence)
• Lowest balance first
• Shortest payoff term first
• Can add one-time or periodic additional payments
  (e.g., bonus, tax refund)
• Savings will vary according to length of debt,
  number of creditors, APRs, etc.

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Sample PowerPay Analysis