When you are right, you are right

I know I have spent more than a few bytes criticizing Obama and his policies. Today I am going to have to agree with one of them. Obama is seeking legislation to reign in the behavior of credit card companies. The problem is the way contracts have been constructed for years. Hidden clauses, excuses to raise interest rates, punishing fees hidden in contracts, and other abuses need attention.

It goes like this: a credit card company sees an account that has a large balance, and they find a reason (having nothing to do with the performance of the account or the debtor’s payment history) to raise your rate to the penalty rate. That penalty rate is retroactive- that is, the rate applies to purchases already made, and the only way to avoid this rate is to pay off the balance. A person with a large balance cannot do this, so the card company makes some fat cash. Example:

Lets say you owe $10,000 on a CC and the interest is 12%. Your payment is $200, with $100 of that as interest. Then, you get in a billing dispute with your cell phone carrier over an early termination fee, and you refuse to pay it. The cell carrier sends you to collections. You credit card company sees this on your credit report, and you are increased to the default rate of 29%.

That means that your interest is now about $240 each month, and your payment is now $340 per month. You manage it for 3 months before being late. You are charged a $50 late fee. You manage to pay late for 4 more months, before catching up. You pay on time for 4 months, then fall behind over the next six, paying when you can, before defaulting.

In that time, you pay $6120 to the bank. Your new balance is $9,600, and over the 18 months you were being charged the higher interest rate, you paid $5,720 in fees and interest and $400 towards your balance. The bank sells your account to a junk debt buyer for 10% of the balance after you have been delinquent for six months, and writes off the remaining 90% of the balance (they still charge interest and fees while you are in default)- $10,038.

So to sum it up: You pay the bank $6,120, the junk debt buyer pays $1,003, and the federal government gives the bank a $2,500 reduction in taxes because the bank shows a paper loss of $10,038 even though they were paid $9,620. You still owe the $10,000 original loan, and then some. All of this over a year and a half. Every month they can get you to pay beyond that year and a half nets the bank another $380 or so in profit, and does not really reduce your balance. The longer they can keep you out of bankruptcy, the more they make. That is why the banks all fund the “non-profit” credit counseling organizations- to keep you out of bankruptcy for as long as possible.

People should honor their contractual obligations, but contracts are binding on both parties, not just to the benefit of one. Interest changes that apply to balances already charged, as well as “universal default” should not be allowed. After all, would you stand for your bank changing the interest on your car to 30% because of a problem that is totally unrelated to the loan?