Credit cards require discipline. The credit card company issues a piece of plastic that enables one to charge based on good faith in the cardholders ability and intent to pay. The cardholder has the responsibility to manage the credit line.
Paying back the credit card debt is just as important, lest repayment can become a lifetime of expensive minimum dues. In the credit card business, managing the minimum due is a key metric. U.S. Regulators use it in their assessment of safety and soundness, as the current OCC Audit manual considers the impact of delinquency aging on writeoffs. Although there is not a hard limit on credit card minimum dues, the OCC “suggests” that it be “calculated as 1 percent of the principal, along with finance charges, and fees”. The CARD Act of 2009 did take an important stand and require that issuers detail the length of time and amount it would cost to pay out the credit card debt. As an example, on an American Express balance due of $7031, if the minimum payment is made over the course of time, it will take 20 years and ultimately cost $20,222.
Shudder the thought! Unless there is a meaningful reason, no one should ever pay just the minimum due.
The CBC reports on an aggressive action in Canada to ensure paydowns accelerate, in an articled entitled “Heads up, Quebec credit card holders — your minimum payments are going up”.
- Bill 134, passed in 2017, will eventually increase minimum payments to five percent of the balance owing.
- Under Bill 134, a provincial law passed in 2017, banks will be required to set the minimum payment at two percent of the balancing owing starting Aug. 1. That percentage is supposed to increase every year until it gets to five percent.
- However, companies aren’t required to phase in the change over time — some may choose to increase that payment to five percent right away. New credit card accounts will start at the five percent mark.
It might be painful, but it will require household debt management.
- But Marc Griffin, a Montrealer with four credit cards, says the change is going to make a big difference when it comes to his debt management.
- Griffin has one card where his payments are going from $37 per month to $182 per month. Overall, he said, he will spend $240 more on credit card payments.
This is a good rule. Here the consumer will knock about 12 years of that 20-year sentence.
Many other markets are more rigid. In Israel, the credit card works more like a debit card with the accelerated settlement. In Mexico, if you want to finance the transaction, there is a special action you must take at the point of sale. In Turkey, the amortization scheme is calculated at 12 months, with some shorter exceptions for consumable products.
Minimum payments may be a consumer burden, but they are also a risk indicator. For the credit card issuer, the interest is great, but if someone perpetually pays the minimum due, risk management flags should rise because of the ability to repay risk.
Overview by Brian Riley, Director, Credit Advisory Service at Mercator Advisory Group
