Credit Card Traps and PowerPay Debt Reduction

Program

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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!!!

Source: Credit Card Smarts calculator, Advantage Publications

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

Annual InterestRate

Credit CardFeatures

4% MinimumMonthlyPayment

2% MinimumMonthlyPayment

19 % APR # Payments

Total Paid

60

$1,467

99

$1,987

15% APR # Payments

Total Paid

55

$1,355

79

$1,584

13% APR # Payments

Total Paid

53

$1,282

73

$1,463

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Low Minimum Payments.Beginning

BalanceAPR Monthly

PaymentsTotal Interest Paid Months to Pay

Off Balance

$2,000 15.04% 2% $2,205.63 169 (14 yrs.)

$2,000 15.04% 5% $589.74 65 (5.5 yrs.)

$2,000 15.04% 10% $269.31 36 (3 yrs.)

Always pay morethan the minimum:

It will save you alot of money.

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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- ExampleDate Charges Payments Balance

April 1 ---- ---- $200

April 12 $135 ---- $335

April 25 ---- $110 $225

11 days @ $200= $2,200

13 days @ $335= $4,355

6 days @ $225= $1,350 Total=$7,905

Average daily balance=$7,905/30 days=$263.50

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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