no third solution

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Category Archives: personal finance

Credit Card Scams Part III: The Balance Transfer Scam

June 18th, 2008

I used to think that the debt-relief commercials that said things like, “The credit card companies want you to stay in debt forever,” were ridiculous. I still think that many or perhaps all of the “get out of debt for free” programs that they offer are scams, but they are probably not any worse than the scams routinely perpetrated by the credit card companies to begin with.

  1. Debt Collection Practices & Impropriety
  2. The Reverse Payment Prioritization Scam
  3. The Balance Transfer Scam
  4. The Penalty Rate Scam
  5. Exploiting Ignorance: Money for Nothing

Last time, I talked about the Reverse Payment Prioritization Scam, wherein the creditor applies payments to balances in the exact opposite order to which any rational person would apply them. The end result is that debtors generally are in debt for longer periods of time and pay far more in interest payments than they otherwise would.  A closely related, and perhaps more devious scam is one which I like to call the Balance Transfer Scam. The Balance Transfer Scam works like this:

There are a number of circumstances under which, if debtor is in reasonably good standing the creditor will generally offer  any number of incentives, including the option to transfer a balance from another card at a more attractive rate (plus a transfer fee of $50-150 depending on a number of factors).

These circumstances can be summed up: when debtor calls to cancel a card on which balance is outstanding, creditor will always offer a balance transfer as a first line of defense. If a card that has not been used in a while, but on which a balance remains, and is being steadily paid down, the creditor will send balance-transfer or cash advance checks to be used for any reason. These offers are generally accompanied by a teaser interest rate of 4.99% or something relatively low. They might even offer 0% on transfers for six months or a year.

Creditors do this because during that year, outstanding balances continue to accrue 15%, 19% or 23% interest! During this promotional period, all of the payments go towards paying down only that portion of indebtedness that isn’t accruing interest, when it is actually in the debtors best financial interest to apply payments in the opposite priority.

The balance transfer scam is attractive to debtors because of its nominally lower interest rate, and the appearance of consolidation: there is only one bill to pay each month instead of several. Along with transfer fees (which are generally a % of the balance to be transfered) which ensure that these loans are only nominally interest-free, the Balance Transfer Scam works in concert with the Reverse Payment Prioritization Scam.

The point of the Balance Transfer Scam is to turn less-profitable borrowers (i.e., those who pay all or most of their balances each month) into more profitable customers and more dependent borrowers. This scam is really attractive to creditors, because by design, the borrower becomes ever more indebted!

Credit Card Scams Part II: Reverse Payment Prioritization

June 17th, 2008

I used to think that the debt-relief commercials that said things like, “The credit card companies want you to stay in debt forever,” were ridiculous. I still think that many of the “get out of debt for free” programs that they offer are scams, but they are probably not any worse than the scams routinely perpetrated by the credit card companies.

  1. Debt Collection Practices & Impropriety
  2. The Reverse Payment Prioritization Scam
  3. The Balance Transfer Scam
  4. The Penalty Rate Scam
  5. Exploiting Ignorance: Money for Nothing

In a previous post, I discussed some debt collection tactics, specifically pertaining to the use of arbitration by credit card issuers.Since, to my knowledge, unsecured debt can’t be repudiated without filing bankruptcy, which may involve forfeiture of assets, there really is no such thing as unsecured debt: it is all eventually secured by your future earnings or your current assets in one form or another.  If a debtor contests the charges against him, he is generally compelled to arbitration which is probably meted out by one of a handful of oligopolistic firms, which are really a judicial arm of the creditors themselves, who are themselves a cartel of debt-issuers, operating largely by the same rules, along the same standards. Arbitration is binding and typically upheld by law courts if the debtor escalates the determination. Creditors also use default judgements issued by law courts to encumber real property held by their debtors. This transforms unsecured debt into a sort of quasi-secured debt, since at the creditors’ discretion, the debt becomes a lien that must be repaid.

There are a number of problems endemic to unsecured debt, not the least of which is the legal and economic tomfoolery which permits its continued existence (to be discussed in subsequent posts).  For the time being, I’d like to focus on some other brow-beating tactics used by credit issuers to basically make debt-slaves out of their “customers.”

Let’s begin with what I like to call the Reverse Payment Prioritization Scam. There may be a technical term for this, there may be a more concise term for this. Frankly, I don’t give a damn. I’m at a loss for words trying to cogently pump out a handful of posts on this topic that all came to fruition in relatively short order, so RPP is what I settled on. The Reverse Payment Prioritization Scame is one method that credit card companies use to keep you in debt longer than you otherwise would be. It works like this:

If you carry a credit card balance month-to-month, and you examine your statement, you’ll probably notice that you have several different balances and each at a different interest rate. You’ll have one rate charged for your carry-over balances, a different rate for cash advances (if any), and probably another rate for promotions or balance transfers (if applicable). What you have is three (or more) balances, each accruing interest individually, but towards which you submit a single payment which is only ever applied to a single balance.

One of the biggest scams perpetrated by credit card companies is how they apply your payments. Although some counselors suggest attacking the smallest balance first, in order to win the moral victory of eliminating one debt in its entirety, anyone with 1/2 of a brain will tell you that it behooves the borrower to apply payment to the debt bearing the highest interest rate, first, and until it is paid in full, and then to the next highest interest rate, and so on. ALL credit card companies do the exact opposite, and to my knowledge, there is no way around this.

If debtor make a $100 payment on a $1000 balance at 15.99%, his balance carrying over is $913. If during this billing cycle, he transfers $1,000 from another card at a promotional rate of 4.99% and a $50 fee, this is what happens: The $50 fee immediately wipes out almost all of the principle he had just paid on the previous balance. Then, assuming a payment of $100/month, it takes 11 months to pay off the transferred balance, during which time that carryover $913 becomes $1,057. If the debtor had begun by paying down the highest interest rate first, repayment of debts is accomplished with fewer payments, and with smaller sum payments of principle and interest in the long-run.

In this example, the debtor might have saved $100 or so over the course of a year or two. This does not sound like much, but if the payments are smaller and/or the debts are larger (the average indebtedness is much more than $1,000) and/or any additional transactions occur, the repayment process grinds to a halt. For instance, if the borrower transfers another balance or makes a new purchase on the card, the subsequent payments apply to that lower balance (permitting the higher-yielding balances to accrue more interest charges). Furthermore, since most credit cards are variable rates tied to the prime rate, any change in that rate will affect the repayment schedule, which means that as the Fed raises interest rates, it becomes harder and harder for borrowers to service these debts.

Of course, it’s easy for critics to sit back and say, “Well, you shouldn’t use credit cards unless you can pay the balance each month.” Lulz. If everyone did this, the creditors would quickly go out of business, because it is an unprofitable business model to give people interest-free revolvers. In fact, this business model can only be sustained in a legal environment that permits the creation of ex nihilo debt-money.

Next: The Balance Transfer Scam

Credit Card Scams Part I: Debt Collection Practices

June 16th, 2008

Updated: This began as a single post, but started the thought process on a series of scams perpetrated by credit card companies.

  1. Debt Collection Practices & Impropriety
  2. The Reverse Payment Prioritization Scam
  3. The Balance Transfer Scam
  4. The Penalty Rate Scam
  5. Exploiting Ignorance: Money for Nothing

A recent article in Business Week highlights some apparently (IMO) improper practices used by credit-card issuers in collecting debts. Most of them use one of several private arbitration companies. The Business Week article, Banks vs. Consumers (Guess Who Wins?) implies that the National Arbitration Forum is probably up to no good and cites a number of business practices that lend (no pun intended), at the very least, the appearance of impropriety.

What if a judge solicited cases from big corporations by offering them a business-friendly venue in which to pursue consumers who are behind on their bills?

…[T]hat’s essentially how one of the country’s largest private arbitration firms operates. The National Arbitration Forum (NAF) … specializes in resolving claims by banks, credit-card companies, and major retailers that contend consumers owe them money. Often without knowing it, individuals agree in the fine print of their credit-card applications to arbitrate any disputes over bills rather than have the cases go to court.

Of course, most of the article is circumstantial fluff, that could very well be taken out of context or could be outliers to reality. I do, however, find it alarming that NAF rules in debtors’ favor only 0.2% of the time. That number strikes me as exceedingly one-sided. Then again, the creditors routinely dismiss arbitrators who are known or assumed to be unbiased debtor-friendly.

One former arbitrator for NAF “said that after she awarded a consumer $48,000 in damages in a collections case, the firm removed her from 11 other cases.”

…”[B]oth sides in each case have the right to object to one arbitrator suggested by NAF, based on the arbitrator’s professional biography, which is provided to the parties. Creditors had simply exercised that option with [that arbitrator.]”

Of course there is some serious assymetry here: the creditors see hundreds or thousands of cases; they have the information necessary to dismiss anyone suspected of not handing down favorable judgments.

The article also mentioned that creditors like to tack on fees for hunting down delinquent debts. What the creditor is saying, is that “You have defaulted on your debt, so I am going to (in a pretty arbitrary fashion) declare that you owe me more than you really do,” in order that you pay them more money. What I say, is that the creditor should have already priced the risk of default, and charged the population of its debtors a sufficient aggregate interest rate to cover that risk profitably.

Creditors make money on the fact that most people do everything they can to avoid default until its the only option available. When they miss payments, they are assessed late payment fees, and/or a penalty interest rate. This means that for many months, sometimes years, they make the bare minimum payment. Assessing fees for the collection of past-due debts strikes me as unconscionable, primarily because (and this may be semantics) the default risk should already be provided for in the interest rate charged on the debt.

My hypothesis, unfounded as it is, is that creditors are preying on most people’s willingness to honor their agreements, they know that most people will continue to try and pay the debt as assessed, and eventually when a compromise is struck, it will be determined on the basis of the higher balance including the spurious fees and penalties. I suppose debtors “agreed” to this in the fine print, but in practice, by the time an account is delinquent enough to be handed to a debt-collector, hundreds or thousands of dollars in late fees and penalties have already been tacked on to the amount due. The borrower has defaulted on an unsecured line of credit. Creditors at this point should be pretty much out-of-luck.

Let’s look at an example. I’ve heard that the average debtor has something like $10K in unsecured credit card debt.

Someone with a $10,000 balance, and an interest rate of 17.99%, assuming a minimum payment of accrued interest + $20 will have a minimum payment of $170 due. Assuming they can afford to pay the minimum plus an additional $50 in principle, over the course of a year, this individual will have paid $2,570 to the creditor, but he has reduced his balance due by only $770. At this rate, it will take him 12 years and $21,000 to pay off his balance. If the individual is really aggressive in his payback plan, eats nothing but Ramen noodle, walks to work, and doesn’t miss a payment, he might pay something like $500/month. At the end of the year, he has paid $6,000 in order to reduce his balance by $4153. At this rate, it takes him 24 months and $12,000 to pay off his balance.

If, on the other hand, this individual misses a payment halfway through the year, and is assessed a modest late fee of $50 and a penalty interest rate of 24.99%, at the end of the first year he has paid approximately $3002 to his creditors, and has only reduced his balance by $498. When you really break it down like this, I think it’s in the debtors best interest to tell the credit card issuer that you are simply unable to pay back that debt, please destroy my credit and never call me again. It’s probably easier to deal with whatever happens to one’s credit score, than it is to spend 12 years trying to pay off that debt.

These problems are compounded by the fact that (in Michigan and I presume in other states) unsecured debt is really quasi-secure. If debtor defaults on a credit agreement, the creditor can, at its discretion, seek a default judgment in a state court. Such a judgment can be filed with the register of deeds in any county in the state, and acts as a valid lien upon real property the debtor owns or comes to own subsequent the date of judgment. Such encumbrance will prohibit the debtor from realizing capital gains on the sale of real property up to the amount of the lien, or from refinancing to take cash out of an equitable position.

I don’t really have a whole lot of advice to offer people in these situations, but I’ll give it a try:

Unfortunately, you probably have to declare bankruptcy in order to repudiate debt like this. You can walk away from a secure debt like a mortgage, but I’m not sure you can walk away from the debt on your Best Buy credit card. The creditor will probably garnish your wages (can they do this?) or file a lien against your real property (jurisdiction permitting).

My advice would be to 1) immediately destroy the card, cash advance checks, etc., call and cancel the card. This is difficult to do, because they don’t want to lose your revenue stream. Resist the offers of 0% balance transfers for six months (to be discussed in greater detail in a subsequent post). Resist any offers to keep the account open. You will probably be transferred to three or four individuals, each of whom will give you greater resistance. Cancel the card. Then establish a budget for yourself, and a repayment schedule (this will be daunting). If you have a good credit history, you may be able to work something out with the creditors. Tell them that you are trying to pay off your debt but given current conditions are unable to. At the end of the day you are dealing with people, not robots, treat them politely and ask for concessions: a lower interest rate, a compromise on the balance due, etc. If you can take out a consolidation loan, do it, but under no circumstances should you take out any additional advances, open any new lines of credit, etc.

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