The Business of Credit Cards - Part II

Monetization Strategy #3: Finance Charges

Finance charges. This term, vague as it may sound, is the source of perhaps more profits than the other two strategies put together.  Finance charges include all the little fees, charges, fines, and penalties for borrowing money, including the dreaded interest payments. To put it bluntly, if you carry a balance, finance charges are where the credit card companies are going to hit you the hardest and for the most cash by far. Let’s take a look at an example to help us understand this:

Gene the hardcore biker has just finished getting his jaw put back together after taking a baseball bat to the face from his inebriated friend, Chuck. The medical bills total $3,000.

“No problem.” Says Gene as he pulls out his Chase credit card and charges the bill. “I’ll just pay it off over time.” Little does Gene know that he has just consigned himself to a form of financial bondage for the next few years of his life! Using a simplified calculation, it is possible to determine how much Gene really pays for that $3,000 medical bill.

Assume that Gene’s card charges a painful 18% interest rate – that’s a $45 monthly profit for the credit card company for each month that Gene carries his balance (not including the increased profits as this interest is capitalized). “Big deal” you might say. Well, allow me to paint a broader picture for you to help put things in perspective. Let’s assume, as is projected by some estimates, that the United States has $1,000,000,000,000 in credit card debt. At 18% interest, how much do credit card companies make per month on that debt? Do the math and you’ll figure out where these credit card companies get all the money to afford to keep sending you prequalified junk mail.

$15 billion dollars. Per month.

Mean Gene the biker is just one hard working part of one colossal piece of profitable pie. Your debt, like it or not, is what keeps many of these companies afloat! What exactly does this mean to you and me, though? It means that it is in the best interests of credit card companies to get you into debt and to keep you there. This can actually lead to interesting situations where those who are carrying a high balance are treated like royalty by credit card companies; not because they actually like you, but because they like the incredible amount of money that you’re earning them on a monthly basis. On the other side of the coin, if you are the type of customer who pays off their balance each month on a regular basis, expect no mercy if you miss a deadline for your payments. Don’t believe me? Check out 10 Confessions of a Chase Customer Service Rep for an enlightening view of the twisted reality of credit card customer care.

Ultimately, between all of these monetization strategies, it is fairly clear which one is simultaneously the most degrading for cardholders and empowering for card issuers. When all is said and done, the only thing we can do to stop the juggernaut of credit card companies is to pay off those cards and keep them paid off!

Popularity: 7% [?]

The Fed Plans Restriction of Card-Rate Increases

That’s right! It’s not a typo.

The Federal Reserve Board put in a proposal on Monday that would prevent credit card companies from increasing consumer rates on existing debt for ANY reason other than default. This proposal also seeks to get rid of double-billing and many of the other unsavory credit card practices that we’ve talked about within this very blog.

It seems that Congress is quite concerned with the amount of credit card debt in the U.S. - remember it’s in the billions! There has been a political firestorm on Capital Hill, with many of the bills introduced having the elimination of risk-based pricing as the focal point of action. While the banks and credit card companies continue their lobbying and opposition of such bills that suggest government regulation of the industry, many experts and insiders are suggesting that an all-out change is inevitable. The financial industry, especially the credit card side, is going to change and credit card companies will no longer have full control over their pricing and practices.

As it stands, card companies are allowed to use outside factors to increase a rate on existing debt, including defaults with other creditors, an overall decline in creditworthiness, and any other factors that deem a customer to be a risk. But, under the new proposed plan, card companies will not be allowed to use risk-based pricing on existing debt and will have a number of other restrictions placed on them as well.

The Fed intends to restructure payment allocation rules in addition to cutting risk-based pricing. Currently, card companies apply payments to the lowest interest rates first. This practice effectively keeps many consumers in debt and certainly needs restructuring. There has been no word on the specifics of how the Fed intends to restructure this policy; however, it is likely that Rep. Maloney’s bill in which she would require the card companies to distribute the payments proportionally to different interest rates, will be used as it is in the best interest for all parties involved.

The Fed has come under heavy criticism in recent years for allowing the practices of card companies to go rampant and now they’re taking it to heart. After all, cutting interest rates can only go so far given the state of the economy. With so many loan defaults, it’s been suggested that the Fed look at other options to help stimulate the economy and now we’re seeing a solid action plan being put into place. However, it is unclear just how aggressive this new proposal will be.

Unfortunately, the Fed’s new proposal could have some adverse consequences for consumers.

Ken Clayton, the director of American Bankers Association’s Card Policy Council, says that such sweeping changes could bring back a wider use of annual fees and increase interest rates across the board. Say goodbye to the days of 0% interest and unlimited rewards! Clayton says that if the Fed takes away their ability to price based on risk factors, to charge interest on a loan, and to simply price their product in general, the reality is that it will have to be dealt with in a different way. That means higher prices and less access to credit.

Consumer advocates don’t think Clayton’s claims of increased pricing will amount to anything more than threats, but they could become a reality. Credit card companies are in the business of making money and the bills that have been introduced, if passed, will effectively cut into the profit they have seen in recent years. As with any business, they aren’t likely to just let that pass. Ultimately, there will be consequences for regulating risk-based pricing, double-billing, and how they apply payments to the interest. The question is; would the end result be marginally better than before?

I think so.

Popularity: 9% [?]

Crazy Carnivals!

A big thanks to Llama Money for taking the time to host the Carnival of Net Worth, and for including my post about the 10% saving rule. Check out the Carnival here, and be sure to take a look around the rest of the site as well - great stuff!

Also, my post about how divorce and credit card don’t mix (a bit of an understatement!) was featured at the Money Hacks carnival. Check it out here.

Hope everyone has a great Wednesday. Stay strong, only 2 days until the weekend!

Popularity: 8% [?]

The Business of Credit Cards - Part I

Anyone familiar with online affiliate marketing knows that credit card programs offer some of the more lucrative payouts for signing up new users; with some companies offering $30 for a completed application or $160 for a new signup, it is readily apparent that these companies really value new customers. Next, factor in credit card rewards programs; we as consumers love them, since we’re essentially getting paid to spend money using a card from bank XYZ! With all the money that these institutions are throwing at us, how do these companies stay in the black? How do credit cards end up being a profitable business for the issuers? Today’s article will delve into the three basic answers to this question.

Monetization Strategy #1: Annual Fees

Perhaps the most transparent and obvious monetization strategy is the annual fee. It’s worth noting that not all credit cards have an annual fee associated with using them. Those that are most likely to have such a fee attached to them are charge cards from American Express and those credit cards which are marketed to those with poor or flat-out bad credit. Annual fees can range anywhere from $15 per year to thousands of dollars per year, as is the case with the black card from AMEX. For many cardholders that don’t use their card very frequently, the annual fee more than pays for the total costs attached to maintaining that individual’s account, as there simply isn’t that much to do in order to do so! For the more prodigious users of plastic, the annual fee only covers part of the costs for that consumer’s use of credit, and must be combined with one of the other two monetization strategies to yield profits.

Monetization Strategy #2: Transaction Fees

The “bread and butter” of ethically palatable credit card revenues is found in the transaction fees. Did you know that credit cards make the issuer a little bit of money each time they are used? As consumers, we don’t often see this cost, but merchants are very familiar with it. Essentially whenever you use your credit card to make a purchase, the merchant accepting the card pays a percentage or fixed amount (depending on the processing gateway and other factors) of the sale to the company whose card you are using.  These tiny amounts of money can really add up over time, and is the price which merchants pay to have access to the convenience of accepting credit cards. This is why when you go to smaller service stations you will occasionally see signs that state credit cards aren’t accepted for purchases amounting to $X or less, or that an additional fee is assessed to credit card transactions of $Y or less. If the business doesn’t put such measures in place, they actually stand to lose money from such transactions!

Next time we’re going to take a look at what is often considered the most nefarious monetization strategy; finance charges. We’ll take a look at some specific examples to see how much the credit card company really makes off of someone’s financial desperation or irresponsibility.

Popularity: 8% [?]

Arbitration Follow-UP: Banks May Pay the Price

A couple of weeks ago I talked about mandatory binding arbitration and the fact that this little-known clause was, in essence, a rewrite of consumer rights. Well, I’m happy to report there may be some consequences for the major banks and credit card companies imposing this clause including; Bank of America, Capital One, Chase Bank, and Citibank.

A federal court in New York allowed proceedings to begin on a lawsuit charging some of the nation’s largest banks with conspiring together to force credit card customers into arbitration. If you’ll recall, this meant that consumer’s were required to give up their right to a trial and their right to participate in class-action lawsuits, among other things. The attorney’s of the plaintiffs’ are claiming that the banks broke antitrust laws, which is grounds to immediately nullify the arbitration clause within each of their respective credit card contracts.

The lawyers discovered - while working on different cases, no less - that the banks had formed an “arbitration coalition” in which they had meet at least 18 times. These meetings were designed to hone in on the specific wording that would strip consumers of their rights and somehow make that legal. Furthermore, upon closer examination of each bank’s contract, the clauses were found to be “almost uniform,” according to Merrill Davidoff, lead counsel. The court overturned a lower courts decision dismissing the case by stating there was no grounds for a lawsuit because the evidence was “entirely speculative.”

But, before you get your hopes up and think that you may get some money out of this lawsuit - goodness knows we all probably deserve a little - the lawyers are only seeking an injunction, which means no money is on the line. However, this is a huge step towards victory for consumers because its preliminary results indicate that banks are going to have to face the music on these antitrust charges.

This new turn of events has put the brakes on the Arbitration Fairness Act of 2007 - a bid by consumer activists to squash binding arbitration. However, thanks to some clever lawyering, these contracts may become null and void. It will depend entirely on the ruling, but the possibility exists that consumers could still file class-action suits against the large companies seeking damages during the times they were unable to seek fair justice.

The case was reinstated as of Friday, April 25, 2008. There are still deliberations that will be taking place before the court comes to any specific decision; however, the fact that they are hearing the case means that lobbyists and advocates of consumer rights are making an impact in Washington. With the Cardholders’ Bill of Rights going before Congress and this case before a federal court, the credit card industry may be facing a huge change by year’s end.

Popularity: 11% [?]

Why Banks and Credit Unions Charge Fees

If you’ve ever taken a look at your disclosures from when you opened your account, you may be surprised to know that banking can very often come with some fees. Just like the credit card industry, these fees can be pretty steep and are next on Congress’ hit list if the credit card bill of rights is passed.

So, what kind of fees are you charged and why?

Overdraft Fees

Most people are painfully familiar with overdraft fees. This is the fee that you incur when you spend more money than you have. Many financial institutions will ALLOW your debit card to be approved for transactions, even when you’ve exceeded your account balance. You can, of course, request that they not allow it; however, they will try to talk you out of it. However, if you keep it, then you’re responsible for paying the overdraft fee per item that overdraws your account.

Some financial institutions take the overdraft fees a step further and charge an additional fee for each day you’re overdrawn. For example, Compass Bank charges $36 per overdraft and then $6 a day that you’re negative up to 30 days. In June they will increase days 7-30 up to $7 a day. That’s a lot of money for an overdraft and a very deep hole to get out of if you fall in. However, most other institutions charge $30 per overdraft. While no one likes to pay them, they do come part and parcel with an account.

There are two reasons for the overdraft fee. Number one, it’s a deterrent/training tool. Those of us working in the banking industry spend a lot of time talking to people about balancing a checkbook. By charging a fee for spending more than you have, banks are able to help teach people how to maintain their accounts. With some people it only takes once to get that fee and they are motivated to learn. Some just get mad and blame it on the bank, but that’s another issue. The point is, it does help financial institutions educate their customers.

The second reason is fee income. This is going to come up a lot. Financial institutions, whether for profit or not, have to make income. That’s how they pay their stock/shareholders, give lower rates on loans, and higher interest rates on CDs and savings accounts. More importantly, that’s how it keeps the front doors open. Paying a few fees here and there is nothing compared to the amount of money you could lose if your financial institution went belly up - if you carry more than the standard FDIC or NCUA coverage that is. There is a point where institutions become greedy, and with the trend being that fee income has gone up 41% over the last four years I’m inclined to think we’re getting to that point.

Returned Check Fee

A returned check fee is when you deposit a check from Joe Schmoe and that check is returned to your bank for whatever reason, i.e. insufficient funds, closed account, etc. When that happens, your bank will usually charge you a fee in the neighborhood of $5. Um, excuse me? How exactly is it your fault that the check was bad? How were you supposed to know? And with new privacy laws it’s not like you can call up Joe’s bank and ask to verify funds. The answer is usually no, they can’t. Even if they can, there’s no guarantee that those funds will still be there by the time the check makes its way through the Federal Reserve. So, you’re left holding the bag on a bad check: you’re out the funds from the check and were charged a fee from your bank. Can we tell I don’t like this fee?

Why, you ask, are you being charged? Two words, my friend. FEE INCOME. There is no other reason for this particular fee - though some places may tell you it’s related to processing the returned item. It’s not really a great deal of work to return them, so that’s just an excuse used to appease their customers. In my opinion, this is one portion of fee income financial institutions should forego.

Cashier’s Checks and Official Checks

I get lots of questions about these kinds of checks and the fees that go along with them. First of all, let me take the opportunity to explain these items as most people don’t realize they are actually the same thing. I get a lot of members freaking out because we offer official checks and it’s not the same as a cashier’s check - well, it is. The ONLY difference between the two is that cashier’s checks are guaranteed by an insurance company as opposed to in-house. In either case, the funds are guaranteed. The time it takes to have a check cancelled and reissued in the event it is lost or stolen will vary depending on the financial institution and the insurance company they use - if it’s cashier’s check.

Now, most institutions do not give these out freely to their customers. There are several reasons and I’m sure you’ve guessed one of the big ones - fee income. However, there is more to it than that. First of all, these are checks and they have to be purchased like any other check. Secondly, if they’re insured with an insurance company, there is a fee involved with that as well. So, since this is a convenience item, some of the cost is transferred to the customers purchasing them. The credit union I work for gives one free check a day and then charges $3 for each check thereafter; however most financial institutions charge anywhere from $7-10.
Statement Fees

These fees can be for paper statements on an account that requires electronic statements or simply for those customers who need to have their statement printed every two weeks. Surprisingly enough, this cost isn’t really related to fee income - though it is categorized under that column for accounting purposes. The cost of paper is a pretty hefty expense, so printing out statements for every customer is expensive enough. To alleviate some of that, financial institutions created electronic accounts that are specifically for those who use things like online banking, debit cards, e-statements, online deposits, etc. When someone wants this type of an account with paper statements it costs more money, so financial institutions will usually have a fee for this service. The same holds true for those coming in every couple of weeks wanting to have statements printed out. Most institutions have statements available up to 12 months back for members to view and print online. If they choose to come into the banking center and have it done, there’s usually a fee - though this one is not always enforced.

There are many more fees associated with the banking industry and it really is a matter of reading through your fee disclosure and being aware of what they are. It can be a nasty surprise when you get your monthly statement and are charged something that you never even knew there was a charge for. Other fees you may see include:

• bad address/dormant account
• overdraft protection transfer fee
• stop payment fee
• wire transfer fee
• maximum withdrawals exceeded (some money markets and savings accounts have restrictions)
• business account fees
• change order fees (usually applies to businesses only)
• in-person visit fees (hey! I’ve seen ‘em)

These fees are also a great way to compare accounts with different banks. You may be getting a so-called “free” interest bearing account with XYZ bank, but what does their fee schedule look like? That “free” account could cost you more than you realize if you’re not careful.

What other fees have you been charged or heard of?

Popularity: 12% [?]

Credit Cards for people with really bad credit

You can get by without a credit card, but who wants to? As if those Visa commercials weren’t annoying enough (you know…the ones where everything comes to a screeching halt when someone pays with cash instead of their Visa Card), you have probably already noticed that there are some things you just can’t do without a credit card like renting a car or reserving a hotel room. What do you do if you have really bad credit?

There is actually a pretty large market for credit cards for consumers who have bad credit. By “bad credit” I don’t mean a few missed payments or some maxed out cards, but instead a credit history packed with disregarded accounts, delinquent payments, and credit balances that are way past their limits. In other words, your credit history would make any traditional lender shudder and run away. Not so for some credit card issuers, who thrive on offering credit cards to people with really bad credit.

It’s not that these companies are benevolent and are actually trying to help people with bad credit. There are a few reasons why some credit card companies are willing to give you a credit card even if you’re in the midst of some major financial issues.

You don’t get much of an available balance. A credit card for someone with really bad credit might feature an initial available balance of $200 or something equally small, but before you start planning out your $200 shopping spree you should keep in mind that there will certainly be some fees that will be taken directly out of your available balance. You might have an issuing fee, an annual fee, a processing fee, and any other number of fees. In other words, your credit card arrives in the mail with a balance already owed, and you haven’t even gone shopping yet.

It’s possible that you could get a card in the mail with a $200 credit limit that already has a balance of $100 or $150 because of all the fees tacked on by the issuer.

The fees just keep coming. Credit card companies catering to folks with bad credit make a lot of money from the fees they charge. You might have a monthly fee, a per-transaction fee, or you might even have to pay a fee every time you call customer service and ask a question.

The interest rates are sky-high. While everyone else in the world seems to be paying a low APR on their credit cards, your rate will be something much higher. It will be so high that you’ll probably be embarrassed to talk about it with other people.

Discharged bankruptcies will be welcomed with open arms. If your bankruptcy has recently been discharged you may think that you’ll have a hard time getting credit. The fact is, however, that if you’re willing to pay the really high interest rates and the barrage of fees then you’ll have no problem finding a credit card company willing to issue you a card. Why is this? The reason is simple: bankruptcy laws do not allow people to declare bankruptcy again within a certain amount of years after a bankruptcy has already been discharged.

In other words, you have to pay the credit card because bankruptcy just isn’t an option. That fact is incredibly attractive to credit card companies.

Why bother?

Obviously, your first inclination might be to scrap the whole idea of ever getting a credit card. If your credit is indeed horrible, though, there are some reasons why you may want to go ahead and pay the exorbitant fees and embarrassing interest rates:

1. You have to start somewhere. You can’t expect prime lenders to jump at the chance to give you a credit card if your credit history is atrocious.

2. Getting a credit card account on your credit history that is actually paid on time will only help your score.

3. The credit card company might eventually lower your interest rate as you demonstrate your ability to make timely payments.

This type of credit card shouldn’t be a permanent solution. You should have the eventual goal of qualifying for a credit card at an average interest rate someday.

You should also keep in mind that you’ll raise your credit score a lot faster if you work on the delinquent accounts you have right now in conjunction with keeping up with payments on your credit card. Don’t think that making payments on your credit card will somehow magically erase years of late payments and delinquent accounts on your credit report. It just doesn’t work that way.

Popularity: 10% [?]

Balance Transfer Checks: A Breakdown

Once in a while you might receive checks from your credit card company that are neatly attached to your monthly statement. They’ll urge you to use the checks to pay off another credit card that is at a higher interest rate, and you can’t argue with the ease of the transaction. Just write a check, send it to the other credit card company, and voila! Instant balance transfer.

This can be a great idea in some circumstances. Sometimes your credit card company will guarantee a really low interest rate on the balance transfers for the life of the balance, meaning no matter how long it takes you to pay off the balance on the transfer it will always be at the low rate even if interest rates rise for everything else. That is, of course, as long as you pay as scheduled because missing a payment will probably result in a huge interest rate increase.

Here are some instances when it makes a lot of sense to use a balance transfer check:

1. You have another credit card that is at a low introductory rate or delayed interest program, and it’s about to expire and you don’t have the cash to pay it off.

2. You have a few credit cards with high interest rates (like department store cards) that you would like to pay off and close, and the balance transfer will be at a lower interest rate.

3. You want to simplify your finances by consolidating some debt, and the balance transfer offers a comparable or lower interest rate to the other accounts you want to consolidate.

A balance transfer is essentially a form of debt consolidation because you’re moving the balances from one or more accounts onto one account. Some people find that this helps them pay down their debt faster because they can focus on one payment every month instead of several payments scattered throughout the month.

You can’t really argue with the mathematics behind a balance transfer if the checks offer a really low interest rate.

Here are some things to be aware of before you take advantage of a balance transfer check:

1. Oftentimes the interest on a balance transfer check starts immediately, because some credit card companies treat the checks like cash advances. This means there is no grace period on the interest accumulation, so it costs you money right away to use the checks.

2. The interest rate on balance transfer checks is not always attractive. Read the fine print and make sure that you aren’t paying off accounts with a check that will wind up costing you more in the long run.

3. You can’t write the balance transfer check for more than what your available balance is. In other words, the credit card company isn’t giving you carte blanche to spend as much as you want. If you write a check that exceeds your available balance you’ll wind up with a ton of fees, at the very least. The worst case scenario is that the check is rejected and you get huge fees from both credit card companies.

4. Some accounts have prepayment penalties. In other words, if you use a balance transfer check to pay off a small loan that has a prepayment penalty attached, you might wind up paying more in fees than you will save in interest charges.

If you make sure you understand the terms and conditions of the balance transfer check then you’re poised to make an educated decision regarding your situation. If it makes good financial sense to use the balance transfer checks to pay off some higher interest debt, go for it.

Don’t consolidate just for the sake of consolidating, though. You want to make sure that you aren’t putting yourself into a worse financial situation by using a balance transfer check. While these checks can really help some people get their finances in order, the checks can also make things a lot worse if they don’t lower your overall interest paid.

Popularity: 10% [?]

Authorized Users: Choose them wisely or not at all

What’s an authorized user? If you have a credit card that was applied for in your name only - yet you want to give someone else access to make purchases on the card too - then you can make that person an authorized user.

In other words, you’re essentially saying this:

“I trust you enough to give you full access to charge up stuff on my credit card, yet you’re not really responsible for making the payments.”

Does that make you shudder? It should.

Allowing someone authorized user status on your credit card can make sense in certain situations.

It makes sense if you’re married, but your spouse’s horrible credit would stop you from getting approved for a card together.

It doesn’t make sense if you give authorized user status to your new boyfriend/girlfriend because you want to impress him or her.

It makes sense if you send your son or daughter off to college with authorized user status on a credit card with a small credit limit for emergencies.

It doesn’t make sense if you give authorized user status to your unreliable friend who begs for help in getting a credit card.

You need to understand that making someone an authorized user does not make that person responsible for making payments on the card, even if the authorized user is the one who wracks up the bill. The bill still comes to you, and you’re still expected to pay it.

You may think that the person you choose as your authorized user will certainly pay you for the charges, but you would be amazed at how quickly relationships can dissolve when money is involved. You may be best friends with someone today, but see how well your relationship can withstand your friend suddenly owing you some money and not being able to pay.

If you have good credit as a result of paying your bills on time and not going too crazy with your purchases, you may be putting all this at jeopardy if you allow someone to be an authorized user on your credit card. That is, of course, unless you don’t mind paying for other people’s shopping trips.

Don’t let someone talk you into giving them authorized user status on your credit card because they want to build up their credit. Being an authorized user on a credit card won’t always show up on credit reports, so it won’t really help in that respect. You would be better off giving your friend a few hundred dollars to put into an account so he or she can open up a secured credit card…but only if the money is a gift and you never expect to see it again. Nothing ruins a friendship like one person owing the other person money.

Adding someone as an authorized user isn’t all doom and gloom, but you do need to choose an authorized user wisely and after a lot of consideration. No matter how much you want to swoop in and solve the credit problems of your friend or the person you’ve wanted to date for months, keep in mind the long-term consequences of your decision.

Everyone knows how easy it is to forget about the eventual result of impulse shopping with a credit card, but it may be even easier to dismiss the nagging feeling of “I really shouldn’t be buying this” if deep down you know that you’re not really responsible for the bill.

Do you really want to give someone this option?

Popularity: 8% [?]

Sunday Round-Up!

Hope you’ve all had a great weekend, and that the prospect of working tomorrow isn’t *too* frightening. This week there have been some great posts in the Personal Finance Blogosphere:

• Seb over at Pinching Copper made a great case for why a housing bailout is a bad idea. While I do feel sorry for many borrowers who are now in a horrible situation, artificially propping up the market is likely to lead to a whole lot more pain in the not-too-distant future.
• Mom from Wide Open Wallet has a fantastic article on how we can bilk ourselves out of true happiness by fooling ourselves into think we ‘deserve’ things we don’t even want.
• Hank from My Investing Blog considers whether we would be better off dumping the income tax and switching to a national sales tax.
• Ginger from Girls Just Wanna Have Funds has a great post outlining 8 recession-proof jobs. Very good reading in uncertain times like these.
• Shanti at AntiShay examines what’s involved in building a Snowflake Business. Fascinating stuff!
• Kevin at No Debt Plan talks about smart, frugal gardening by recommending you only buy plants that ‘pay dividends’. Check it out!

Have a great week everyone!

Popularity: 8% [?]