Obama Signs Credit Card Reform Bill - Politicians Also Need Financial Literacy

Following the lead of President Barack Obama who signed the Credit Card Accountability, Responsibility, and Disclosure (CARD) Act of 2009 on Friday, Canadian Finance Minister Jim Flaherty has proposed changes to Canadian credit card legislation in order to provide more transparency for Canadian credit cardholders.

One of Flaherty’s stated goals is to help credit cardholders understand how much the credit they are getting will cost them in the long run.  

How will he do it?

His proposal is to make credit card companies provide a calculation for each customer that shows the total cost of paying off his credit card balance when only a minimum monthly payment is made. 

While the idea may sound good at first blush, it is deeply flawed. 

In fact, Mr. Flaherty needs an education in regard to how credit card companies operate and why providing a monthly, updated calculation for each and every consumer is not the best to provide that transparency, even if providing such a calculation were feasible, which it is not.  

FLAW #1: THERE IS NO ONE FORMULA

First of all, credit card companies do not all use the same formula for calculating the minimum payment. In fact, the same credit card company may use different formulae from customer to customer. One account may be required to pay only one and half or two percent of the balance each month while another is required to pay three percent.

Also, some credit card companies - but not all - use a formula that incorporates the interest charges into the monthly payment. For example, the customer may be required to pay one percent of the monthly balance plus the interest charged for that month.

FLAW #2 - VARIABLE INTEREST RATES

Then there is the large number of credit card owners who have variable interest rates on their credit cards. Many borrowers who chose this option have seen their interest rates fall three and four percent over the last four years. So any calculation that was done based on those initial rates would be far off by now.

To make things even more convoluted, if a cardholder’s minimum payment included calculated interest and was also based upon a variable rate, then the minimum payment would also change with every change in the prime rate.

FLAW #3 - A SOFTWARE NIGHTMARE 

In Money-Saving Credit Card Secrets we discuss the significant difficulties that credit card companies have with their software now.

It is inconceivable to us that a program could be devised that could handle these constantly changing variables for hundreds of millions of credit card customers with any kind of accuracy.

FLAW #4 - DOOMED TO BE INACCURATE

Billions of credit card statements are issued each year. By the time the customer gets the information - unless he or she is accessing it on-line - the information is inaccurate, for reasons explained in our book.

At best, the total provided could be no more than an estimate because consumers keep charging throughout the month and balances keep changing from day to day. A calculation made by a customer at the moment when he or she is making a decision about how much to pay is a much smarter way to go.

CREDIT CARD DISCLOSURE: SIMPLER IS BETTER

Our suggestion is to require credit card companies to put a notice on the front page of each bill - in LARGE, READABLE PRINT - that directs customers to an on-line interest calculator, along with a call to action like this:

“Before making only a minimum payment, calculate how long it will take you to pay off your balance this way. Then decide whether you can afford to pay more this month so you can  shorten your pay off time and reduce the interest you will pay over the life of your loan.”

This would require a one-time change to statements and no dealing with nightmarishly complex software that can break down or miscalculate.

To those who complain that not everyone has Internet connection - we just do not accept that as a valid excuse to make things ridiculously complex and increase the administrative costs for credit card companies who - make no mistake - will find a way to pass those increased costs on.

Those people who do not have computers can access the calculator by visiting a public library. Any librarian will help a visitor access a web page when that person brings the URL ( Internet address). (Right now you can access our interest calculator.)

Also, credit card companies could be required to include an extra page with a graph showing approximate interest due on various balances over one, three, five and ten years, so those who cannot or will not make the trip to the library (or to a friend’s home with a computer) can see the difference that paying more each month makes.

REVERSING THE TREND

Of course credit card companies do not want to put this information anywhere, much less on the front of credit card bills, because it will reverse the profits that they have worked so hard to create.

All their actions have been geared to taking the consumer’s attention off the long term cost of debt so consumers would be in no hurry to pay it off.

Their most effective strategy to string out repayment and increase the amount of interest received on credit card debt has been to reduce the minimum payment due.

More on this in tomorrow’s post.

Let me just wind this up by saying that people are starting to realize that personal financial literacy must be a priority, which is what we hoped would happen when we wrote Money-Saving Credit Card Secrets.