RESEARCH Business Economy
CREDIT
Consumers clueless about how credit-card payments are calculated

Mark Reutter, Business Editor
(217) 333-0568; mreutter@uiuc.edu

9/1/02

CHAMPAIGN, Ill. — "WARNING: This credit card may be detrimental to your financial health." While such a label sounds farfetched today, a movement to force credit-card companies to inform consumers of the high costs of using plastic is growing, according to Charles Tabb, a law professor at the University of Illinois at Urbana-Champaign.

"A lot of credit-card users don’t have a clue as to how the monthly minimum payment is calculated," Tabb said. "Paying the monthly minimum means paying slightly more than interest, which means the consumer can spend decades paying off even relatively small sums."

Tabb pointed out that auto and appliance loans include a payment schedule that gives consumers a clear idea of the costs of paying debt.

A new California law would require lenders to include timetables spelling out the cost and time it takes to repay a credit-card balance. Statements would include information such as, "a $1,000 balance takes 17 years and three months to pay off at a 2 percent payment rate, at a total cost of $2,590.35."

The law was due to take effect July 1, but was delayed when a group of lenders, led by the American Bankers Association, won a court injunction. The ABA claims that the statute circumvents federal law by forcing lenders to treat California customers differently. A court hearing is scheduled for later this month.

Tabb, who teaches bankruptcy law, said better disclosure may help stem the rising tide of consumers defaulting on their debts. "Research indicates that debt can be addictive, not unlike nicotine, and that consumers who depend on credit-card debt systematically underestimate the costs of compounding interest and fall deeper into debt."

Roughly 5 billion credit-card solicitations were mailed to Americans last year, up from less than a billion a decade ago. Even consumers who are behind in card payments will receive mailings offering them new credit cards. By "maxing out" on a card and paying only the monthly minimum, consumers can rack up tens of thousands of dollars in debt in a matter of months.

"The credit-card industry complains about the increase in consumer defaults and personal bankruptcy filings, yet it continues to indiscriminately encourage people to ring up debt. Why? Because with 20 percent or higher interest rates, credit cards are hugely profitable for lenders."

Tabb recommends that in addition to improved consumer disclosure, companies should better account to Wall Street the risks associated with credit cards. A good starting point, he said, are new federal guidelines requiring lenders to improve accounting methods and place more reserves for bad loans, especially in the "subprime" market. Subprime refers to loans to consumers with low earnings profiles and spotty repayment histories – a market that Citigroup, MBNA Corp. and other credit-card giants have aggressively entered in recent years.