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The Downside of Low Interest Rates

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Boy, did we Canadians go on a debt binge last year. Our total consumer debt, excluding mortgages, reached $1.4 trillion at the end of 2009. We are now officially the most overextended country of the big 20 developed nations. For all the pain we see from US families, we now owe more than Americans, on a per capita basis, and even more than the average Greek family! Right now, we are in debt $1.44 for every dollar of income. If there were to be a setback in the economy again, we’d be in big trouble.

Or, as we talked about a month or so ago, when rates keep climbing, we’re in the same trouble. Don’t forget, consumer debt, other than probably our fixed-rate car loans, most everything else from lines of credit to credit cards are on variable rates. That means, rates go up, you’re paying that increase the following month.

Yesterday, the Bank of Canada raised interest rates another quarter of a percent for the second time. On each $100,000 of debt that is not on a fixed rate, these two rate increases will cost you $500 a year and rising.

Behind the scenes, the federal government is taking steps to clamp down on our debt loads. A few months ago, the Federal Finance Minister announced changes to the down payments for mortgages, and the total that can be refinanced on a home.

The next wave of pressure, and nobody has talked about this, yet, is your credit cards. Starting in a few months, your minimum payment will be going up. The good news: you’ll have it paid off faster. The bad news: It’ll hit your budget to pay more as a minimum payment.

Starting with MBNA, the largest issuer of MasterCards in Canada, August will see a new and higher minimum payment. They will be the first, but not the only ones, to change the way the payment is calculated.

Why? Remember that I always say what happens in the US will come here? Well, their new credit card regulations require a box on your statement to show how long it would take to pay off the balance when making minimum payments. That will happen in Canada this fall, too. So when they increase your payment, the staggering time it’ll take to pay it in full won’t look quite so ugly when you see it in a few months.

The third reason, and it’s a big one, is that our debt load has started to increase the arrears and write offs that card issuers are having. So if they increase your payment, they get paid back faster, and have less risk. But we can also start to look for limits to be cut back for a ton of people in the next wave of clam downs. In the US, $1.5 trillion has been cut from credit limits and they’re not done yet.

New Credit Card Regulations Right on the Mark

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Yesterday, Finance Minister Jim Flaherty introduced a number of new measures aimed at reigning in credit card practices. Here is a rough rule of thumb: If the credit card industry and the NDP are both unhappy, the regulations strike the perfect balance.

Yes, the credit card industry is complaining that their world will end, while Jack Layton claims the Finance Minister has capitulated to the bank. No, we will not need to have a wake for card issuers, they’ll continue do just fine. And a cap on interest rates won’t, shouldn’t, and can’t happen. Just like there won’t be caps on our incomes, that no car can sell for more than $20,000, or that retailers can only sell their products at a certain maximum markup.

What the Finance Departments’ regulations do address are four major areas which will benefit all card holders in measurable ways:

1) There will be a mandatory 21 day grace period of no interest on new charges. “Credit card inflation” has seen grace periods shrink from up to 26 days down to as low as 15 over the past few years. After all, the shorter the free ride, the more profitable each account becomes.

But the new regulation goes much further: Every card will now have this grace period, even if the account had a balance the previous month. What more than three-quarters of people don’t realize is that they never did have any grace period if they did not have a zero balance the previous month! Years ago, card issuers took that free ride away. It was “use it or lose it,” and even if the balance forward was one penny – all new charges were subject to interest immediately.

2) Credit card statements will now include a warning line that will show the length of time it will take to pay the balance in full, if making only minimum payments. And that will be a rude awakening for most people, and hopefully an incentive to step up their repayment plan.

3) Payments will now be allocated to balances in favour of card holders. Up until now, any payments were always applied to the lowest interest rate portion first. So, someone with part of a balance on a cool 1.9% rate, and a portion at 19.9%, could pay as much as possible, but not one dime would go towards the high rate portion of the balance. The new regulation now forces card issuers to apply any payments first to the higher rate balances.

4) You control your credit limit. The main goal of card issuers is to have us owing the largest amount of money and to pay the smallest payment possible. THAT is how they maximize their profit. To help their customers with this “going broke” project, limits keep increasing. After all, when the balance gets to be more than two or three months’ worth of income, there isn’t a chance someone can pay off the balance. Great for them – bad for the customer.
The new regulation requires card holders to explicitly consent to a limit increase. While a smaller limit does impact someone’s credit score, let’s be honest: If we claim we don’t let our credit card balances get beyond reasonable, why do we really need a limit of $10,000 or more?

In all these four areas, Finance Minister Flaherty found an appropriate balance of fairness to card issuers and us card holders. In fact, all four of the main regulations go beyond what the U.S. Government was recently able to pass in their “Credit Card Holder Bill of Rights.”

However, the most powerful impact Minister Flaherty can make is yet to come in the formation of the Finance Departments’ Financial Literacy Task Force, announced in the last budget. Why? Because I would bet that the vast majority of people reading the four changes will go: “I didn’t know that.” And THAT is precisely where the focus and efforts should be directed: towards financial literacy, starting in the school system where more than 85% of teenagers have never taken a course on finance or credit.