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→Bankruptcy Reform and the Credit Card Industry - When a Good Plan Goes Bad
Since 1989 Jon Noble has consulted with various companies and law firms specializing in bankruptcy, mediation, debt settlement and credit restoration. He assisted these firms in developing their new business, operations and marketing strategies.
Since 1989 Jon Noble has consulted with various companies and law firms specializing in bankruptcy, mediation, debt settlement and credit restoration. He assisted these firms in developing their new business, operations and marketing strategies.
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== Bankruptcy Reform and the Credit Card Industry - When a Good Plan Goes Bad ==
== Bankruptcy Reform and the Credit Card Industry - When a Good Plan Goes Bad ==
In January of 2003, the Consumer Federation of America released a study entitled “Facts about Consumer Debt and Bankruptcy”. The study compiled data from the Studies by the Congressional Budget Office, the Federal Deposit Insurance Corporation, and independent economist’s link to the rise in consumer bankruptcies directly to the rise in consumer debt.
'''How Much Is The Average American Family Indebted To The Credit Card Companies And How Did They Get There?'''
Currently, there are well over a billion credit cards in circulation. The average American household has about a dozen credit cards and carries a balance of more than $10,000. Approximately 60% carry the balances owed from month to month. In fact, Americans owe more in credit card debt than they do for education.
Since 1997, credit card issuers have nearly doubled the amount of credit they offer to consumers, to more than $3 trillion dollars. In fact, credit card loans have had the fastest growth of any type of consumer loans.
Between 1997 and 2002, revolving debt increased from $554 billion to $730 billion, the vast majority coming from credit cards. During the same period, between 1997 and 2002, credit card companies increased the number of mailed solicitations to consumers from 3 billion to 5 billion. To put it into perspective, about 50 mailings/offers went out to each American Household in a year, not including telephone solicitations, TV commercials, etc.
In addition, direct solicitation to college students has also increased. Most cards are available to many colleges and students – students that have little to no income, no established credit history and with no parental signature required. Student loan provider Nellie Mae found that in 2000, 78% of undergraduate students had a least one credit card. This is up 67% from 1998 figures. A 67% increase in 2 years. The average balance for an undergraduate in 2000 was $2,748. In 1998 the average balance was $1,879. Almost a 50% increase. Not to be outdone, the average graduate student leaves with a degree, most likely a hefty student loan and an average credit card balance $4,776.
To peer into the future (from a lending perspective and potential profits), here is another fact. In 1998, more than one quarter of all college students reported paying late on a credit card at least once in the previous 2 years and more than one quarter also reported using a cash advance to pay their debts. This type of behavior will most likely lead to the student bearing the classification of high risk on their credit rating, which in turn will result in them paying a higher interest rate when obtaining future lines of credit. And statistically, high risk borrowers typically carry a higher debt burden, pay more interest, usually make the minimum payments and suffer more defaults.
'''How Much Is It Costing The Average Amercan Family To Service These Debts And How Much Are The Credit Card Companies Making?'''
In 2000, about one-third of Americans with incomes below the poverty line spent more than 40% of their income on debt repayment. Those households with moderate income spent 20% on debt repayment and middle income families spent about 14%.
Credit card companies earn about 75% of their revenues from the interest paid by borrowers who do not pay in full each month. Industry analysts estimate that making minimum monthly payments on a credit card with a balance of $2,500 will take 34 years to pay off and would exceed 300% of the original principal balance owed. Put all these facts together and it doesn’t take a rocket scientist to figure out why they target low income families and start students down a path of long term debt repayment.
Some credit card companies have instituted charges or even canceled credit cards for consumers who pay in full each month, preferring customers with large credit balances that pay minimum monthly payments.
Taking a look at credit card profitability, Bankcard profits increased in 2001 to their second highest level in the last 5 years (3.24% of outstanding balances). So you don’t have to pull out your calculators; that’s about 23 billion dollars in profits. The majority of growth can be directly attributed to, back then, the increasing “interest rate gap” between the benchmark rate set by the Federal Reserve and the interest rate charged by card issuers to consumers. For an example, in 2001, the Federal Reserve cut interest rates by 4.75% but major bankcard issuers cut their rates by only 1.35% on average.
'''Who Asked For Bankruptcy Reform?'''
Now let’s go to the year 1995 before all of this was happening. Why? In 1995 creditors urged then President Clinton and Congress to establish the National Bankruptcy Review Commission. That’s right, the new Bankruptcy Reform Laws that were enacted last year, has been being pushed by the Credit Industry since 1995. Creditors were pushing for legislation that would restructure the guidelines for filing a Chapter 7 Bankruptcy (known as a straight bankruptcy where the vast majority of unsecured debts (credit card companies fall under this category) are eliminated). The new restrictions would force many consumers that once would qualify for a Chapter 7 to file under for bankruptcy protection under Chapter 13 (which is reorganization) and further require that some type of payment be made to the unsecured creditors, which in most Chapter 13 filings at that point in time was never the case.
It is interesting to point out that the credit card companies were the ones requesting bankruptcy reform. They were the ones saying that people are abusing the system. Not Bankruptcy Judges, Trustees, Congress, consumer groups, etc. An article published in the National Association of Bankruptcy Practitioners prepared by Mary Rouleau in January 2003 entitled “The Truth About Bankruptcy” showed that the panel was formed and the initial drafts of the report showed that the credit industry did not establish the burden of proof that people were abusing the system or how they were suffering tremendous losses. So, you would think that that would be the end of it. Sad to say about this next turn of events, even sadder still is how is speaks volumes about how laws are passed in this country, is that the credit industry sent a letter to Congress denouncing the National Bankruptcy Review Commission’s (NBRC) initial opinions and began to spend multi-millions of dollars on public relation campaigns and lobbying efforts to discredit the NBRC and long story short, continued their efforts until the new laws were enacted.
The supporters of this law (the credit card industry) said it was needed to help curb the massive abuse of people who filed for Chapter 7 bankruptcy that wanted to simply “walk away” from their financial obligations. Opponents (economists’, consumer groups, bankruptcy judges/attorneys) said that the changes would be especially hard on low-income working people, single mothers, minorities (interesting that the credit card industry has been targeting these high risk individuals for the past decade, while simultaneously perusing the law changes in bankruptcy.) and the elderly. In addition, it would remove a safety net for those who have lost jobs or face mounting medical bills.
'''What Were The Basic Changes In The Bankruptcy Law?'''
The law bars those with above-average income from Chapter 7 -- where debts can be wiped out entirely -- except under special circumstances. Those deemed by a new "means test" to have at least $100 a month left over after paying certain debts and expenses must file instead a 5-year repayment plan under the more restrictive Chapter 13. The means test is a chart that provides the median family income for each state and the living expenses set by the IRS for day to day living expenses (food, transportation, clothing). You must use those allotted amounts. To see what the average is in your area, go to www.usdoj.gov/ust
In addition to this “means test”, an individual wishing to file for relief under Chapter 7 must first seek credit counseling services and receive a certificate of insolvency.
Basically, anyone seeking to file a Chapter 7 bankruptcy has to go to a credit counseling service that interviews the individual and conducts an analysis of their overall financial situation to determine if they truly can’t afford to pay back their debts. The credit industry had hoped that by forcing someone to seek credit counseling, it would give them a better chance of recovering their money. Using the logic that people had money, they just didn’t want to pay their credit card bills. If not, they still have the means test and the potential to recover something through a Chapter 13 bankruptcy.
'''Did Bankruptcy Reform Actually Work?'''
Let’s take a look at the people who usually file for relief under Chapter 7 bankruptcy, the so called “abusers of the system”. In 90% of all filings, one of three things occurred that forced the consumer to file for protection. The consumer suffered a job related issue (layoff, cutback in hours), suffered a medical crisis or went through a divorce.
While it is true that Bankruptcy filings have been at an all time high over the past decade, it is also true that consumer debt has kept pace. Thanks to, yes, the credit industry.
Studies have shown that most people do not want to file for bankruptcy relief. Even most bankruptcy attorneys will tell you that the majority of their clients come from advertising and not referrals. I can tell you from personal experience having been involved in the field for the past 15 years that people don’t look forward to having to file for bankruptcy. Most people are very nervous during the process and are overwhelmed by the anxiety of seeking relief.
There was a study published by the National Association of Consumer Bankruptcy Attorneys back in March 2006. The study concluded that forcing consumers into credit counseling – a key provision of the reform Act, was a waste of money and did little to weed out the so called deadbeats trying to use bankruptcy to avoid paying their debts.
Additionally, there were six major credit counseling firms surveyed that dealt with 61,335 bankruptcy filers since Oct. 17, 2005. Out of those 63,335 people, only 3.3 percent of people in the study were eligible for a debt management plan and could avoid filing bankruptcy. The remaining 61,000 people got the relief they needed but not before spending a combined total of $4.7 million dollars in fees to the credit counseling agencies for their analysis and certificate of insolvency. Now remember, cccs has some new laws that are going to take effect here shortly. One of the provisions of the new law is that anyone seeking credit counseling that can not afford it, the service must be offered free of charge. So it will be interesting to see how long a cccs company can offer to perform an analysis and issue a certificate of insolvency (which is required in order to file for bankruptcy) showing that someone is insolvent and not get paid for it.
The above numbers were no surprise to anyone in the industry. Research showed before the law was passed that only about 3.6% of all people filing for Chapter 7 would be candidates to file for relief under Chapter 13. and industry consultants also concluded that credit card companies could cut their losses by more than 50% if they would institute minimal credit screening.
It is also interesting to note that during the reform review process, industry consultants concluded that if credit card companies would institute better minimal credit screening, they would cut their losses by more than 50%.
So, why wouldn’t they do that? Because lending to people who are a high credit risk is very profitable. More profitable to them than if they restricted the numbers of people they would extend credit to. Remember that credit card companies earn about 75% of their revenues from the interest paid by borrowers who do not pay in full each month. By loosening up their lending practices and issuing credit to people who are a high credit risk, they can charge them a higher interest rate and make more money because they know that these consumers will just make their minimum monthly payments each month.
I would submit that the credit card industry was banking on the new reform to limit the amount of American consumers that would be eligible to file for relief under Chapter 7 and force them into credit counseling (where they would receive all of the money owed with some interest) or at least force the majority into a Chapter 13 were they would recover a good amount of it.
After looking at the facts how can one not see a pattern and a feeling of distain for such practices? You have an industry that is preying on people that they shouldn’t be giving the type of high credit lines to. They double their efforts to entice new customers. Target students and low income people who they know will be indebted to them for years to come and at the same time, push to change laws that would stop those individuals that they have taken advantage of from getting the help they need when they suffer a job loss, divorce or a medical emergency?
On average, 1 out of every 60 families went bankrupt last year. If you take into consideration, high fuel costs, adjustable rate mortgages that are due to reset over the next several months (there are about $400 billion in loans that will rest this year and another $2 Trillion that are due to reset next year) and the amount of credit card debts the average family is carrying, we will past that figure next year and the year after that.
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== Sometimes Filing for Bankruptcy Just Makes Sense ==
== Sometimes Filing for Bankruptcy Just Makes Sense ==