One of the first things you learn in credit management is that the minimum due payment sets the stage for the potential risk on a credit card account. At a 2% minimum due, the cardholder may think they can afford to run up the card to the limit of say $2,500, and just pay about $50 per month. On the other hand, in credit policy, if you see the customer only pays the minimum due, this can be a long relationship that has limited potential. This is an indication the cardholder is potentially over-the-head in debt. If credit line utilization is high, that is if they are using a large portion of their available credit, and if they only pay the minimum due, it is a fair assumption that the cardholder household budget is under stress.
The credit card business can make tons of money from cardholders who pay only the minimum due, but by definition, these customers are risky and do not represent the best way to generate income. Some credit policy types refer to those customers as “Perma-debt”. Just pay the minimum and it will take more than 10 years to extinguish the debt. What a credit manager wants to see is high usage, quick repayment, and continued high usage; in contrast, you don’t want your cardholders struggling to meet the minimum due.
Banking regulators in Canada are taking a different spin at helping customers reduce debt. As The Montreal Gazette reports, minimum payments must calibrate to 5% of the balance, rather than 2%.
- Beginning Aug. 1, new regulations governing credit card payments in Quebec will require that the minimum monthly payment on a credit-card bill be no lower than two per cent of the balance.
- The province’s Consumer Protection Act also calls for the minimum monthly payment threshold to be increased by half a percentage point annually after Aug. 1, 2020, until it reaches five per cent after six years.
Officially, Bill 134 of the Parliament of Quebec is a modernization of consumer credit rules to reduce credit costs and it is a much better way to reduce costs of credit than many U.S. presidential candidates have. When you attempt to reduce the cost of credit, you can do so by either contracting the repayment time, as Canada is doing, or you can reduce the rate as some U.S. politicians suggest. If you take the latter course, that is reduce interest rates, banks lose their margins and must tighten lending to reduce risk. Increase the minimum due, and everyone can be happy.
Shortening the term is the better option. Consumers pay a little more each month, but they reduce the term and accelerate repayment.
In this case, there are two ways to skin a cat in the noble goal of reducing consumer credit expense. Looks like Canada’s approach will work nicely, but even then, the real message should be “NEVER just pay the minimum due on a credit card”. Pay more and see the principal balance wither away. This reduces the next month’s interest due.
Overview by Brian Riley, Director, Credit Advisory Service at Mercator Advisory Group
