Navigating Credit Card Traps: Strategies for Effective Debt Reduction

1. Credit Card Traps and PowerPay Debt Reduction Program

2. When you invest, compound interest is your friend :-) When you pay interest on credit cards and loans, compound interest is your enemy :-( The Other Side of Compound Interest

3. 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!

4. What is the Worst Credit Card Trap of All? • Teaser rates? • Default rates (penalty APRs)? • Late fees? • Over-the-limit fees? • Minimum payments?

5. Credit Card Minimum Payments!

6. 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

7. Credit Card Payback$1,000 Balance ($20 Minimum Payment)

8. Low Minimum Payments.

9. Factors Affecting Finance Charges • APR (interest rate) • Grace Period • Balance calculation method Result: significant effect on the cost of credit.

10. 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

11. Average Daily Balance- Example

12. 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

13. 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)

14. 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

15. 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

16. 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%

17. 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

18. 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

19. 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

20. “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

21. 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

22. 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

23. 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

24. 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

25. 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

27. 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

28. Required Information For a PowerPay Analysis • Name of each creditor • Balance owed • Monthly payment (minimum or above) • APR (interest rate)

29. 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.

30. Sample PowerPay Analysis