Credit Basics
Application Denied
How new credit card tricks and traps can ruin your life.
By Kristyn Kusek Lewis From Reader's Digest August 2007
One saw his credit card's interest rate nearly double when an online payment was clocked in ten minutes late. Another watched the rates on all three of his cards soar after a single late mortgage payment. A third found herself facing a triple whammy: higher interest rates, late charges and -- when those penalties helped push her over the credit limit -- added fees for crossing that line.
In a country where an estimated 51 million households carried an average credit card debt of $9,659 last year, these tales show how buying on credit can quickly spiral into big financial trouble.
Hefty fees, soaring penalties and punitive interest rates as high as 32 percent are boosting profits for card companies. But they're also dealing crushing blows to cardholders by damaging their credit score -- a number now used as a reference point by everyone from potential lenders to prospective employers. Any misstep that lowers that score significantly below 700 can have far-reaching consequences. A late payment here, a raised interest rate there, and suddenly home loans, job opportunities and dreams for the future can slip out of reach.
Patricia Stevens* is a 47-year-old legal secretary from Indiana. She and her husband, a skilled tradesman, have three grown children (the youngest will finish college next spring). Together, the couple earn about $130,000 a year.
Over the course of about six years, while their children were in college, the Stevenses amassed $33,000 in credit card debt. Along the way, they missed a couple of payments. That pushed their interest rates from the 12-to-13-percent range to about 24 percent. Keeping up with the bills, Patricia Stevens says, was hard. And it got harder last year when she took a six-week disability leave while being treated for uterine cancer. During that time, she received just 60 percent of her usual pay.
Her treatment done, Stevens returned to work. But, with her debts in mind, she began to look for a higher-paying job. Her search soon led to a promising opportunity at a different law firm. She aced her first interview and was told her salary requirements were in line with what the firm was offering. Then she hit a snag.
The hiring manager, who had told Stevens she thought she would be a “great fit,” explained that the company's standard preemployment background check would include a review of her credit history.
“I turned nine shades of red,” Stevens says.
When she told the interviewer that might be a problem because her credit score was in the low 400s, the woman said it would hurt her chances of landing the job. When Stevens asked why, she says, the woman responded that bad credit “didn't show diligence” and that the firm felt that people in debt might be desperate enough to be tempted to steal. That ended Stevens's job hunt. She says she has no desire to go through more interviews simply to run up against a credit check again. She and her husband have decided to sell their house and move into a smaller place to help pay their bills. They've also signed up with Consolidated Credit Counseling Services, Inc., a national firm, in hopes of wiping out their debt altogether. In a year or so, she hopes, she'll be able to start looking for another job again. But until she and her husband get their finances straightened out, they're stuck right where they are.
*Some names have been changed to protect the subjects' privacy.
Pay Late, Pay the Price
Sean King* says he and his wife have always been careful about paying bills. So last year, the 49-year-old father of three from Cincinnati was stunned when the rate on one of his cards shot from 14.99 percent to 27.99 percent. He says it took more than a hundred e-mails and phone calls to find out why.
“They said I made a late payment in 2005,” he says. “When I asked for the details, I found out that my online payment arrived at 3:10 p.m. -- ten minutes after a 3 p.m. cutoff.”
Despite a sparkling credit history, he can't get his rate lowered. “I'm trying to pay down $3,200, but I'm not making much headway at 27.99 percent interest,” he says. “I've got two kids in college. I can't afford a bad credit rap.”
The Debt's in the Mail
Anyone with a mailbox knows pre-approved card offers have spread like a virus, reaching epidemic proportions since Congress changed federal laws in 2005 to make it harder for debtors to seek bankruptcy protection. In 2006 the number of credit card solicitations sent to consumers, most of them preapproved, rose by 30 percent, to more than eight billion.
These offers aren't just annoying. They can be dangerous. Consider Richard Christner. The 45-year-old New Mexican had always dreamed of running his own plant nursery, like his parents and grandparents before him. When he decided to try a few years ago, he used preapprovals to open five cards for start-up capital. Then a massive drought hit, and Christner didn't have the resources to weather the dry spell. He accepts blame for borrowing so much but notes that when credit cards were harder to come by, he couldn't have gotten himself in so deep. As it was, he had to shut down his business, leaving a $50,000 debt.
Doing the APR Hustle
One reason these offers are so hazardous: The terms on the envelope rarely apply. A teaser rate (“zero percent APR!”) printed on the outside of a mailing can mask the annual percentage rate truly offered. In fact, actual rates are, on average, 264 percent higher than those touted by preapproved offers. And cash-back offers can hide fees or high interest rates.
Elizabeth Warren, a Harvard University law professor and bankruptcy expert, learned how confusing such offers are while teaching a class of third-year students. She passed out one that touted “3 percent cash back,” and asked them to determine the true interest rate and just how someone would take advantage of the cash-back offer.
“It took the entire class of 80 about-to-be Harvard Law grads an hour of back-and-forth, calling out and debating the terms, to figure out the actual terms of the deal. Even then, they weren't completely sure they had it right.” (The class's best guess: The interest rate was 14.99 percent; a consumer got “cash back” by paying 17.99 percent.) “How do card companies expect the average American to clearly understand these agreements?”
Every Bill Can Hurt
Something else consumers may not understand is what's called universal default. Under this practice, card issuers can raise a cardholder's interest rate because of a default on an unrelated bill. It's just one of the justifications card companies use to raise rates since the industry was deregulated in the 1980s. A late payment on a car loan, therefore, can mean a higher rate on many cards. To make matters worse, the higher rates can be applied to an existing balance.
Rich Mullikin, 38, of Galveston, Texas, found out firsthand about universal default after he missed a single house payment last January and saw the interest rates on all three of his credit cards increase. "One jumped from 17 to 32 percent, and the other two are around 29 percent," he says. "Now the payments have doubled, and even if I make a payment of $100, there's $90 in interest." At that rate, he says, he'll never get ahead.
Small Checks, Big Pain
Millions of Americans pay only the minimum required on their statement each month. Many struggle to do even that. This traps them into shelling out more money over a longer period of time because of the interest that's tacked on to their balance with each passing month.
The problem has worsened in recent years as people were allowed to pay off less and less of their balances. According to a Massachusetts Public Interest Research Group study, the minimum monthly payment shrank from an average of 5 percent to as low as 2 percent. The result: Some minimum payments might not cover even fees and interest. It got so bad that federal regulators stepped in, pressuring credit card companies to recalculate bills so that minimum payments now comprise interest and fees plus 1 percent of the principal.
Paying the minimum can hit students particularly hard, especially if they wind up using school loans to pay their bills. (As a group, students took on almost 24 percent more in card debt from 2001 to 2006.)
Elizabeth Potts Weinstein, 32, is one of those who dug herself a deep hole even before starting a career. A lawyer and financial advisor in San Jose, California, she amassed $6,000 in card debt while attending law school. When she couldn't make her minimum payments, her interest rates rose; plus, she faced late and over-the-limit fees. The latter averaged $35 a month, she says (like late fees, over-limit fees have nearly doubled since the mid-1990s).
Weinstein's finances are okay today, but her debts dogged her for years. “It doesn't seem like a lot to me now,” she says. “But back then, it was the end of the world.”
Tips and Tricks
How to Beat Card Sharks
If you're considering a credit card offer, carefully examine the terms of the contract. If you don't understand something, call the issuer's customer service department. If you're not satisfied with the response, don't sign up.
· Remember that the due date on your card statement is just that. A postmark date is not the same thing. Because many card issuers impose ultra-specific cutoff times (American Express, for example, won't process some payments received after 12 noon in a customer's time zone until the following day), try to make your payment, by mail or online, well in advance.
· One way to avoid going over your limit (and facing extra fees as a result): Go to the card company's website. Most will alert you via e-mail when you creep close to your cap.
· If you've historically been a good customer, it can't hurt to ask the customer service department to waive over-limit or other fees.
· Similarly, if your interest rate goes up, it's worth asking to have it lowered. A study by the Massachusetts Public Interest Research Group found that when cardholders requested a reduction, almost six in ten got their rate reduced by at least a third with just one five-minute call.
New Rules to Curb High Rates & Fees?
Federal legislation introduced in May could eliminate or at least limit some of the harshest card fees and penalties, including:
• Retroactive interest hikes applied to existing balances.
• Duplicate over-limit fees.
• Billing plans that add interest to bills paid on time but not in full.
• Fees for paying bills online or via phone, which some card companies now charge.
