Despite the numerous interest rate fluctuations that have occurred over the last several decades, minimum payment determination for credit cards largely remained unchanged. That is, until recently. Some consumers may have ‘felt’ that something had changed on their billing statements and in their monthly budgets. It’s not consumer imagination. Mimimum payments due on credit cards have indeed increased. The change represents a move towards greater economic health for both consumers and the nation.
OUT WITH THE OLD
During the past three years, bank regulators had repeatedly expressed concern about the escalating credit card debt that was and continues to be prevalent in the United States. Regulators firmly believed that banks were luring consumers into a perpetual debt cycle with their offers of credit cards that required lower and lower monthly payments. To halt this never-ending debt phenomenon, the regulators mandated banks to implement changes to their respective minimum payment structures within a three-year period. Some banks opted for a gradual approach and increased payment requirements over time. Others, however, waited until the last hour in December 2005 to raise payments; thus, delivering payment shock to many consumers in the New Year.
Prior to this regulation, most banks required only a minimum payment of 2% of the average daily outstanding debt. Such a payment would do little to reduce debt, especially in a high interest rate environment. For example, if a consumer’s credit card interest rate was 24% or greater, the principal portion of the outstanding debt would never get reduced with only minimum payment applications. Even at lower interest rates, the minimum payment severely limits the debt reduction and extends the time frame for full debt repayment. To illustrate, an outstanding debt of $5,000, at 16% APR, would take 26 years to pay in full if only the minimum payments were applied.
IN WITH THE NEW
The Bankruptcy Abuse Prevention and Consumer Protection Act became law in 2005. The Act outlines bankruptcy reform and specifically addresses minimum payment requirements for credit card debt. The new requirements mandated banks to set their minimum payments to reflect the amount necessary to equally pay down the respective principal debt over a five-year span. In practical terms, this equates to a monthly payment of about 4% of the principal, plus finance charges. The Act further prevents consumers from filing for bankruptcy relief in order to erase credit card debt. The debt remains and will have to be satisfied during the consumer’s lifetime.
THE POWER OF FUSION
Many consumers opt to consolidate their debt. The advantages of consolidating debt are plentiful and include:
- Reduces monthly cash outflow
- Spreads the debt over a longer repayment period
- Offers the convenience of writing one check each month
- Saves on taxes by increasing the home interest deduction
Credit, used wisely, is a powerful tool. Education is the key to effectively managing your credit card debt.
Michelle Castle provides mortgage loans to all of North Texas and Southern Oklahoma. Call Michelle Castle at (903) 892-1998 if you are looking for a home loan in North Texas and Southern Oklahoma.