Thursday, August 20, 2009

New Credit Card Act doesn’t help everyone

Before I begin, let me first say that I am fully supportive of the new Credit Card Act.

The new Credit Card Act of 2009 becomes official today. They sound good for consumers, but will they really help you? Just to recap, banks must comply with parts of the recently passed Credit Card Act of 2009 by:

  • mailing bills to their customers at least 21 days before their due dates (change from 14 days) and
  • providing at least 45 days' notice to their customers before making a significant change to their rates or fees (change from 15 days)
  • Credit card consumers will be allowed to avoid future interest-rate increases and pay off any outstanding balance over time under the original rate terms.

Credit card companies like to segment and compartmentalize everything, including people. The basic method of segmentation is by credit score (Sub-Prime, Prime, Super-Prime), and spend habits (transactor, revolver).

The credit score segmentation is defined by:

  • Sub-Prime – People with credit score up to 640
  • Prime – People with credit score from 640 to 720
  • Super-Prime – People with credit scores over 720

Nothing new there. But, within these different credit score segments, there are two main types of spend categories:

  • Transactors – those who pay the full balance each month, and
  • Revolvers – those who carry a balance each month
  • Of course, hybrids (Trans-volvers) do exist but we’re not considering that group here.

Credit card companies make money from:

  • Each transaction – each time you use a Citi/Amex or any other credit card, that bank makes a fraction of a penny
  • Interest charge from revolving balances – this is pretty clear
  • Fees – again, pretty clear

Most of these you may have know already. However, what you probably didn’t know is that credit card companies make the most money off the Sub-Prime population, while the Super-Prime population gets all the benefit of great interest rates and rewards! In fact, Super-Prime customers, on average, only generate $200-800 in profit over the entire lifetime! That’s because Super-Prime customers have lower interest rates and great rewards that minimizes profits. That’s why credit card companies try to make most off their Sub-Prime customers.

Now, let’s look at these rules one by one:

  • 21 day bill notice – this rule is really intended to help the Sup-Prime population. By giving consumers more time to pay, credit card companies generate less fees from those who pay consistently late (Sub-Prime population – otherwise their credit would be better). However, this rule can hurt all revolving population, depending on how they perform these transations. By giving consumers additional 7 days to pay their bills, that means additional 7 days to charge those who are revolving. That’s a whopping 23% jump in additional interest generated from the additional 7 days, which means that your payoff of any revolving balance will take LONGER because you’re paying down a smaller portion of your balances. Some companies may have better functionality where this happens only once, however, the minimum balance is determined by the total amount due when the bill is produced, and the additional 7 days still have interest that's not stated in the minimum balance. So, this really helps those who pay their bills in full.

Further, we also don’t know why the Sub-Prime population pays its bills consistently late. Is it because they don’t have the money or because they are poor money managers. If latter, the additional seven days won’t help them.

  • 45 day interest change notice – I think this is actually a good bill, but one that really only help those with better credit. For example, if you have a $10,000 balance on your credit and you get a 45 day change of rate notice from your credit card company. What will that person do after receiving the notice? Will that person pay off the full balance? Probably not. The best case scenario is to open a new card with lower interest rate and do a balance transfer……but again, these are available to those with better credit.
  • Old charges under old rate, new charges under new rate – I believe this is the best part of the act. We (consumers and credit card companies) made an agreement when we signed up for a new card, and that included the interest rate. Sure the companies should have the right to change rates, but not on the items consumers already purchased under the old terms. I love this rule. However, which population is more likely to get a rate change? That’s right, Sub-Prime!

Now, credit card companies now slashed their profits and they have to find ways to make up for the loss. Thus far, companies have already increased interest rates while reducing credit limits on many of their customers. Some are now changing to a variable APR model that sounds good now since the interest rates are so low, but can increase interest rates easily. Finally, any companies are slashing, or cutting back, their rewards programs. Not only that, companies will find other ways to add fees to your cards. The people who are hurt from this? The Super-Prime population. They won’t get the high rewards and the low interest rates they’re used to getting. Don’t get me wrong, I’m fully supportive of these changes that helps the Sub-Prime group, but I thought you should know the consequences of this seemingly Rosy rules.


Ray was a former Analyst with a major credit card firm developing various financial models and marketing strategies for the credit card firm. Ray has also sent millions of mail solicitation to potential customers, and chances are, some of you received some from Ray.

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