Credit Basics

Portfolio Media, New York (February 28, 2006)—A new rule requiring consumers to make higher minimum payments on their credit cards could boost the charge-off rate reported by card issuers, JP Morgan Chase &Co.’s chief executive warned on Tuesday.

At a presentation to investors Rich Srednicki said the rule will bring about higher bank charge-offs, which will amount to a couple hundred million dollars by late 2006, as well as supplemental costs in early 2007.

Because of the new regulation, JPMorgan foresees a looming $300 million in costs in its second half of 2006, which will compensate part of its savings it will be able to realize.

Under the new minimum-payment rule, which went into effect for all card-issuing banks on Jan. 1, cardholders must make monthly payments that reduce their debt by at least 1%. IN addition, cardholders who were already required to pay 1% of their outstanding balance, will now pay monthly interest charges, as well as any fees and the original 1%.

In effect, more consumers are expected to default on their credit card payments and delay paying off their balance, which will hinder banks from collecting interest payments from consumers.

To Office of the Comptroller of the Currency implemented the rule to credit card companies as a means to make consumers pay bills faster and cut down interest.

Howard Dvorkin, CPA and author of “Credit Hell: How to Dig Out of Debt,” expects monthly payments for credit-card holders will double to about 4% of balances.

“Americans are in a debt crisis. High interest rates coupled with low monthly minimum payments have been robbing the American people of their future. The savings rate is now, according to the Federal Reserve, -.5%. This measure by the OCC hopes to stabilize the American people’s future financial stability,” Dvorkin said.

Dvorkin acknowledged that many card-holders may become overwhelmed by the higher monthly payments.

“While this may be hard on many consumers, it will be a benefit to them once they have their debt paid down. This may also deter many people from overspending and overcharging in the future,” he said.

Credit card companies maintain the new law will have short-term setbacks, but long-term gains.

The assumption in the rule is that card-holders would not make just their minimum payments if they only knew how much more this ultimately costs them, according to Alan Kaplinsky, senior partner at Ballard Spahr Andrews & Ingersoll, LLP, in Philadelphia.

“But if banks do respond but increasing their minimum payment amounts, then, perversely, the net effect could be to disadvantage consumers who have been getting by making only minimum payments. Some of these consumers may end up missing payments, throwing them into default, and triggering the application of higher interest rates,” Kaplinsky said regarding how the rule will affect default rates.

In fact, Kaplinsky noted that the kinds of card-holders most likely to be adversely affected are those at the margins and those who have an unanticipated emergency, such as a major medical bill, the loss of a job, or the victims of a natural disaster, like Hurricane Katrina.

Approximately 43% of American families spend more than they earn each year, and on average, Americans spend $1.22 for every dollar they earn, according to the Federal Reserve.

There were 2,043,535 consumer bankruptcies filed in 2005 as opposed to 1,552,967 filed in 2004. Last year’s consumer bankruptcy filings were the highest on records according to bankruptcy experts at Lundquist Consulting, Inc. The minimum-payment regulation is an attempt to safeguard against these bankruptcies.

Dvorkin said counselors and creditors can help consumers struggling to pay off their debt.

“If people find themselves having trouble paying debts they should contact their creditors to let them know that they are having trouble making higher payments and request to work something out,” Dvorkin said. “Default rates may rise and creditors should try to help consumers as best they can until they are bale to meet the higher minimum monthly payments.”

--By Erin Coe

--Additional reporting by Cat Fredenburgh