Minimum Payments Don't Cut Debt

It's a credit-stressed consumer's nightmare: You juggle your bills each month, paying both Peter and Paul, but figure you're at least treading water. After all, you paid everything your credit card companies asked for and didn't use the cards all month.

Then you open up your new statement from MBNA or Citibank, or Chase, and guess what? Your balance still went up, not down.

How? Because many credit card companies, including the industry's leaders, have long set minimum payments so low that they can actually be outraced by accumulating interest and fees.

That scenario, known as "negative amortization," has long outraged consumer advocates, who call it the ultimate credit card trap: Pay the minimums and you'll never need to ask how long till you're free and clear. The answer is never- not until you're lying in your grave.

Even federal regulators seem to agree. In January 2003, they issued "guidance" to the nation's credit card lenders, telling them to eliminate formulas that enable a borrower to pay what's asked and still lose ground.

In the Orwell-speak of bankruptcy regulators, the guidance wasn't just a gentle suggestion. "It is mandatory," said Kevin Mukri, a spokesman for the comptroller of the Currency, which oversees national banks.

But for reasons known only to bank examiners, some of the biggest names in credit card lending are just now getting around to it. Right now, for example, MBNA allows you to pay as little as 2.25 percent of your balance. If you owe $2,000, that's $45 a month.

How long would it take to pay off debt? That depends partly on interest. At 8 percent, about 4 1/2 years. At 18 percent, you'd need about six years - the target that lenders have been told to meet, Mukri says.

But if you were at MBNA's top rate of 28 percent, you'd never get out from under.

Fees - $30 or $40 for a late payment or for creeping over your credit limit - magnify the problem. Combine those with penalty rates, which many banks impose for a late payment to any creditor, and it's easy to see why some borrowers just get sucked in deeper and deeper.

But come Oct. 1 - or July 1, for new accounts - MBNA is eliminating that nightmare scenario, as regulators asked. And its leading competitors are headed in the same direction.

The new approach is simple: The minimum payment will start with the previous month's interest and fees, then as a portion of the outstanding balance - 1 percent at MBNA and Citibank. And at least one issuer, JPMorgan's BankOne, will also add any amount that's past due or that tops a credit limit.

Simple or not, the new rules still don't bode well for the financially strapped.

No one knows how many cardholders will be affected or how severely. The greatest concern centers on the fraction, probably fewer than 10 percent, who make minimum payments each month - the same ones most likely to incur fees that could easily double or triple the minimum.

"People who are late on their payments - their payments are going to go up dramatically," warns Patty Hasson, director of Consumer Credit Counseling of Delaware Valley. "Consumers are going to have to come up with more money in their budgets at a time when they're already having difficulty making payments."

Still, it's hard not to welcome a change that eliminates a notorious credit trap. Take a closer look at the numbers, and it's hard not to wonder what took them so long.

Say you're that cardholder who owes $2,000 at a rate of 28 percent. With a minimum payment of $45, you'd be sinking deeper into debt. But at just $47 a month, you'd be clawing your way out - albeit as a price of $8,000 in interest over the next 18 years.

Even a few dollars more would make a big difference. At $60 a month, you'd pay about $2,000 in interest, and be done in less than six years - assuming, perhaps unreasonably, that you never miss a due date or use the card again.

Consumer advocates have long argued that credit card bills should include a payoff statement - a projection of how long it would take a cardholder to pay off a balance by paying the minimum.

Card issuers have fought them at every turn, plainly fearful that customers might shy away from using plastic if they had a clear answer to the question.

With the new rules, at least they'll no longer have the say: "Forever."