Partners (Number 1, 2006)

Credit Card Payments:
Can Consumers Handle the Minimum?

Consumers may be facing higher minimum payments on their credit card balances. The federal banking regulatory agencies issued joint guidance in January 2003 that called for lenders to raise minimum monthly payment requirements for credit card debt by year-end 2005.

In the past minimum payments required by industry standards typically did not cover monthly interest charges and fees, and thus could create negative amortization. Rather than reducing the debt, negative amortization actually causes it to build over a prolonged period with no definite repayment schedule.

From a regulatory perspective, this type of financing is bad for both consumers and lenders: it not only increases and prolongs the debt liability of the consumer, but it also leads to higher credit risk for the lender. To address this problem, lenders have been required to raise minimum payment requirements to cover finance charges, fees and some portion of the principal balance to assure the debt will be repaid in a reasonable time period.

Impact on consumers
The new guidelines are designed to benefit consumers in the long run by helping reduce their debt burden. However, the change comes at a time when consumers are carrying record levels of debt, bankruptcy filing criteria have been tightened, and energy costs and interest rates are rising. These circumstances could make the transition difficult for consumers whose debt burden is excessive relative to their income.

Consumers who fomerly paid only the minimum monthly amount are most heavily impacted by the new policy. Minimum payments would have increased from the former rate of 1-to-2 percent of the outstanding balance to a rate of 3-to-4 percent or more to cover fees, finance charges and a partial reduction in the principal. The minimum monthly payment may have doubled for some card holders. Industry estimates vary, but studies by Cambridge Consumer Credit Index and Cardweb (respectively) indicate that anywhere from approximately 11 to 16 percent of credit card holders made only the minimum required payment.

According to’s October 19, 2005 weekly survey of large bank and thrift product rates, the average annual percentage rate on credit cards was approximately 13 percent. At that rate, a consumer making the average minimum payment requirement of 2 percent on a $10,000 balance would need 33 years to pay off the debt, and the total payments would include more than $11,000 in interest. Under the new guidelines, a 4 percent minimum payment requirement would reduce the payback period to less than 13 years and would lower interest payments to less than $4,000, according to an Associated Press article by Eileen Alt Powell in July 2005.

Impact on lenders
Bank of America was one of the first to raise the minimum payment in 2004, and the bank experienced a corresponding increase in credit card charge-offs as a result.

Other companies like MBNA (recently acquired by Bank of America), which services receivables for SunTrust, AmSouth, and Regions Banks, have phased in the new requirements by establishing new clients with the higher payment structure when they become card members and applying the changes to existing customers at year-end. Compass Bank, which already required borrowers to pay 2 percent of the balance plus outstanding interest and fees each month, did not need to make any changes to its minimum payment requirements.

Although the guidelines were created to serve consumers, the timing of the decision may present problems for some borrowers, particularly if employment and wage growth remain lackluster. As a result, banks could see higher delinquency and loss rates on credit card portfolios in the coming months as consumers try to juggle higher debt payments and higher costs of living.

In addition, some analysts believe lenders could experience slower growth in credit card receivables as consumers shy away from building additional debt in light of the higher minimum payments.

The majority of consumers, who already pay more than the monthly minimums on their outstanding credit card debts, should not be significantly affected by this change. Over time even heavily indebted consumers will benefit from less negative amortization and faster principal repayment. Nonetheless, some borrowers may be finding it difficult to make minimum payments that became significantly higher in 2006, and banks may feel the fallout.

This article was written by Lisa Easterwood, financial analyst in the Supervision and Regulation Division at the Atlanta Fed.

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