No one wants to file bankruptcy. Everyone who comes into my office is fearful of what will happen when they file: will I ever be able to buy a house or a car? will my name be published in the newspaper? will the trustee come to my house and take my 10-year old television? For clients of a certain age, however, the stress is even worse. They are in sheer mental agony over the possibility of discharging their debts. The comment I often hear is “this is not how I was raised. I was raised to pay my debts no matter what.”
This is what I tell them.
For thousands of years, there have been usury laws, which prevent a lender from charging a ridiculous rate of interest. That is until 1978. That year, the United States Supreme Court, gave American credit card companies a tremendous victory that effectively gutted the usury laws. In Marquette National Bank of Minneapolis v. First of Omaha Service Corp., 439 U.S. 299, decided on December 18, 1978, the Supreme Court ruled that national banks are only bound to the usury laws of the state where they are located rather than the state where they lend the money.
Here is a link to the case: http://supreme.justia.com/us/439/299/
Part of being a good person is that you pay your debts. However, the flip side of the coin is that a good person also lends money at a reasonable rate of interest. Nowadays, however, the credit card companies will rocket up your interest rate to 32% any time they want. EVEN CREDIT CARD COMPANIES THAT YOU ARE PAYING! This is called universal default. When a card issuer looks at your credit report and sees something it doesn’t like – perhaps trouble you’re having with a debt to someone else, perhaps an error or even identity theft – it will get antsy and raise your interest rate on the debt you’re current on because they are making a guess that whatever is causing trouble on your credit report will spread. So even if you had no intention of ever defaulting on the debt, the credit card company just made it more likely that you will default on that debt. This leads to a domino effect of all the other creditors having the same reaction, raising the interest rate, and raising your payments from something reasonable to something outrageous. In fact, they will typically all drop your credit limit at the same time as well, causing you to incur over-limit fees even on accounts where you were not even close to maxed out.
One of my clients, a widowed former-teacher, was in this boat. She brought me a credit card statement that added together the interest rate and the effect of her over-limit fees and brazenly right there on the statement showed a 65% effective interest rate!
My clients will say, “but they’re right, I agreed to it.” But did you really agree? You signed the back of the card, a balance transfer check, or a charge slip. You didn’t read the 20-page cardholder agreement and agree to unscrupulous practices like universal default, taking away your right to a jury trial, or the card issuer’s ability to change the terms of the deal unilaterally at any time. The card issuers send each American hundreds of solicitations per year and essentially promise free money. They make the agreement longer and longer, giving you a very reasonable incentive not to read it and just trust what they disclose in the big box – the interest rate and billing cycle. You read the box, and you think: “okay, this is fair. I will be fair with them and they will be fair with me.” But you are reading it as an honest person. They are writing it with the pens of very expensive lawyers. The contract is what is known as a “contract of adhesion,” because one side writes it and says “no negotiation – take it or leave it.”
You and the lender have both taken a risk. You borrowed the money in the hope that you will prosper and be able to pay it back. The lender took the risk that they may get their money back with interest or may not. Who has taken the bigger risk? You, by far. If you don’t pay, you suffer a great deal – you lose financial security, self-esteem, health, opportunities, sometimes even your spouse. The bank will act like it is the true loser. It will call you day and night and make you feel like dirt for putting your own needs – food, housing, transportation, health – ahead of their profits. What they don’t tell you is that even if you don’t wind up paying in full, the bank still wins! They will typically collect much more in interest than they expected to collect (they may even get paid more in interest than you originally owed!) for the years that you were paying on time and then, after they jack up the interest rate to the maximum and force you to default, they are able to write off the rest of the debt on their taxes at the higher rate Once you begin to realize how much money the credit cards make, your sympathy for them will begin to diminish. Chase, for example, in 2007, made $15 billion in profits on $71 billion in revenue and $1.5 trillion in assets! (http://investor.shareholder.com/jpmorganchase/annual.cfm). They are not starving. They are not even suffering.
So when I tell my clients about what happened in 1978 and how the credit industry has changed since then, they understand a little more about what they’re going through, and they feel a little better about themselves and can focus on their real problems – feeding their families, paying for their houses, getting a job, recovering from illness – rather than the stress the credit card industry wants them to feel.
Looks like Smashing Pumpkins was only a year off when they wrote the lyric “shakedown 1979.”
Ron –
Don’t overlook the payday lenders. I routinely see contracts with a stated interest rate of 800% or more. My personal record was a payday loan with a stated interest rate of 1,227%. That’s right – OVER ONE THOUSAND PERCENT. Didn’t they used to put the mob in prison for that? I guess the banking industry has better lobbyists.
CardTrack estimates that Americans will have $1 trillion of revolving debt by the end of this year. Revolving consumer credit is at a record $969.9 billion and is growing by 4.8% per annum.
Don’t cry for the credit card companies. They are making money even though the economy is hurting.
When you charge 30% interest, you can still make a ton of money even when 40% of your customers go bankrupt. It’s called loan sharking, and it’s been a wonderfully profitable business since the beginning of time.
Capital One Avoided a Big Mess
By MATTHIAS RIEKER
September 10, 2008; Page B5D
In its four-year transformation from a credit-card issuer into a bank, Capital One Financial Corp. stayed away from one of the most popular businesses in banking: mortgages.
Capital One dodged a bullet with that approach, but its reason for avoiding mortgages is counterintuitive: It has long felt that unsecured loans are the better deal.
That strategy has kept Capital One, with $151 billion in assets, more resilient in the credit crunch than many of its competitors. Despite rising consumer delinquencies, Capital One has maintained its dividend — even raising it in January to $1.50 from 11 cents — and a strong capital base. The company’s shares have fallen, but not nearly as severely as bank stocks overall.
Mortgages are commonly considered much safer than credit-card lending, particularly in an economic downturn. Capital One says mortgage lending is risky because lenders put too much faith in the value of the housing collateral.
The low interest rates bankers charge their mortgage borrowers don’t reflect the risk of rare but vicious real estate downturns, like the current one.
In credit cards, however, the risk of default is an integral part of the pricing strategy, and therefore Capital One is taking a much more calculated risk than a secured lender. “We underwrite solely on the ability of the individual to pay,” rather than the value of the collateral, Mr. Perlin said.
“Credit-card lending is a higher-loss business than mortgages, but that does not make it a higher-risk business,” Mr. Perlin said. “Every credit-card loan we make we expect will have to live through an immediate degradation of something like 40%” to withstand the rigorous loss assumptions of Capital One’s underwriting model, he said in an interview.
Capital One always underwrites “assuming that we are entering a recession,” he said. “That’s the kind of stress that we want our loans to be able to withstand.”
But in the mortgage business, “markets don’t price that risk,” believing that rising home prices will protect the lender. “If you try to price for the risk in the middle of the good times, you won’t be able to write any loans because the competition will take it away from you.”
…..
American Express, however, has cut the credit lines of at least some customers who, “based on our modeling, have a higher risk,” Chief Executive Kenneth Chenault told investors in July.
Some analysts said it would be prudent for Capital One to do the same.
Mr. Perlin disagrees. He said delinquent customers have already maxed out their lines of credit, and those who are current might take such action badly. “People who have credit opportunities elsewhere will leave, so you work against your own best interest,” he said. “Those might be your best customers.”
[...] This is ridiculous – your needs come first, especially if you have a debt with the outrageous interest rates we’re seeing nowadays. 5. The practical response that 9/10 of my clients come up with? Screen [...]
I totally just read all of that, and since I’m not a debtor or a lawyer, I still don’t know what it’s saying, but I’m going to read it in my free time and leave comments. You discuss the reasons why gambling is bad by talking about the time I stole a whole bunch of money and stuck it all in a stuffed animal vending machine. good times. Those are some ridiculous interest rates though. I hope that never happens to me.
=[ i meant should discuss the reasons** my bad