Buzz
Your credit card company might offer you the option to pay off your balance gradually with small, minimum monthly payments. While this offers some flexibility, it’s primarily created to keep you in debt.
Not long ago, I saw a well-known card issuer advertise “the ability to pay off your balance over time” as a perk of using their card. While this might sound appealing, it’s more of a business strategy than a customer benefit. The revolving balance generates interest, which is how credit card companies profit. Many people recognize this, but Forbes delves into how minimum payments are intentionally designed to keep you in debt.
In the 1970s, most credit card companies set a minimum monthly payment at 5% of the outstanding balance. However, Andrew Kahr, a financial services consultant, persuaded many issuers to lower that figure to 2%.
The reduced payments provided customers with greater flexibility, but as Kahr pointed out, ‘of course the bank has a potentially much more profitable account.’ Once issuers saw how lucrative this shift was, Kahr’s idea quickly became widespread. By the early 2000s, 2% minimum payments were the new standard.
In a Frontline interview, Kahr explained what most consumers already know: credit card companies favor customers who carry a balance, as they are more profitable:
...it’s the cardholders who revolve their balance, use the credit, pay finance charges, cover overhead, and generate profit for the lender. Meanwhile, someone who pays in full within 30 or 45 days doesn’t incur any fees, effectively using the card for free. The bank does earn some income from this due to the structure of the clearing relationship with MasterCard and Visa, but it’s not enough to cover costs—profits are made from lending.
Around a decade ago, federal regulations were implemented requiring issuers to cover fees and accrued interest in minimum payments. This made it a little easier for consumers to avoid a never-ending debt cycle. However, nowadays, most issuers only charge 1% of the balance, plus interest and fees. (Forbes notes that some credit unions and a few major issuers still charge 2%).
On the other hand, none of this matters if you pay off your credit card balance in full and on time, which you should aim to do anyway to avoid interest and fees. Also, this isn’t about blaming credit card companies. A lower minimum payment can help consumers during financial hardship, after all.
However, if you carry a balance every month, it's more beneficial to view this flexible 'perk' for what it truly is: a strategy to keep you in debt. For more on the subject, Forbes’ full post is worth reading, and the complete Frontline interview is also available at the link below.
Image credit: openDemocracy.
