Credit Card Traps and PowerPay Debt Reduction Program
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!!!
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Source: Credit Card Smarts calculator, Advantage Publications
Credit Card Payback
$1,000 Balance ($20 Minimum Payment)
A n n u a l In terest R a te 19 % APR C red it C a rd F ea tu res # P aym e nts T o tal P aid 4 % M in im u m M o n th ly P a y m en t 60 $ 1 ,46 7 2 % M in im u m M o n th ly P a y m en t 99 $ 1 ,98 7
15% APR
# P aym e nts T o tal P aid
55 $ 1 ,35 5
79 $ 1 ,58 4
13% APR
# P aym e nts T o tal P aid
53 $ 1 ,28 2
73 $ 1 ,46 3
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Low Minimum Payments
B egin n in g B alan ce $ 2 ,0 00 APR M o nth ly T o tal In terest P aid P aym en ts 2% $ 2 ,2 05 .6 3
.
M o nth s to P ay O ff B alan ce 1 69 (14 yrs.)
1 5 .0 4 %
$ 2 ,0 00
1 5 .0 4 %
5%
$ 58 9 .7 4
6 5 (5 .5 yrs.)
$ 2 ,0 00
1 5 .0 4 %
10%
$ 26 9 .3 1
3 6 (3 yrs.)
A lw a ys pa y m o re th a n th e m in im u m : It w ill sav e y o u a lo t o f m o n ey .
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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
D ate A pril 1 A pril 12 A pril 25 C harges P aym ents B alance ---$135 ---------$110 $200 $335 $225
11 days @ $200= $2,200 13 days @ $335= $4,355 6 days @ $225= $1,350 T otal= $7,905
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A verage daily balance= $7,905 /30 days= $263.50
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 applicant’s 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 Don’t 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
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