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How Big Banks Will Crush You

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Last year's credit card reform bill was supposed to be a saving grace for strapped borrowers. Instead, it has simply reaffirmed the fact that when you put your finances in the hands of profit-seeking companies, even the government can't save you from your own excesses. The only effective way to fight the credit-card companies is to get rid of your debt once and for all.

Law by a thousand cuts
If it seems like we've been talking about credit card reform for months, it's because many provisions of the law have taken that long to go into effect. After passing a full year ago, many of the major provisions of the bill became effective as of February. Provisions prohibiting retroactive rate increases and bait-and-switch interest rate provisions, as well as notice provisions requiring 45 days before a card issuer makes material changes to your credit-card agreement, have all been law for six months now.

This time around, the latest provisions that took effect earlier this week target fee income. Card issuers must meet certain guidelines and limits before charging late fees and over-limit fees. Inactivity fees are no longer allowed at all. The net impact is to try to make sure that those consumers who've gotten in over their heads aren't in a position where penalty fees prevent them from ever digging themselves out again.

The anticipated response
As these provisions take effect, some cardholders will likely see some benefits. The typical late fee will likely fall from the typical current $39 charge to around $25, which is the safe harbor specifically given in the law.

But the way banks are responding will likely cost these borrowers more in the long run. Banks have raised their interest rates to the highest level since 2001. And when you consider that the prime rate is currently at a rock-bottom 3.25%, the spread of 11.45 percentage points is the biggest since the 1980s.

Here are just a few of the measures that card companies have taken in response to the legislation:

  • Capital One Financial (NYSE: COF  ) , Wells Fargo (NYSE: WFC  ) , and Citigroup (NYSE: C  ) have boosted the interest rates they charge new credit card customers by between one and three percentage points.
  • Bank of America (NYSE: BAC  ) is paying more attention to other banking relationships, such as deposit accounts, in making decisions about extending credit.
  • Discover Financial (NYSE: DFS  ) has seen a 60% reduction in the amount of balance transfers it authorized for customers compared to last year.

These moves have counteracted the benefits of the Credit CARD Act and put borrowers in almost as bad a position as they were in before the act. Improved disclosure rules at least give borrowers a better sense of just how bad a situation they're in, but when it comes to helping them fix it, the new legislation hasn't accomplished much.

The only way to win is not to play
What you need to understand about the credit card business is that with so much money involved, big banks and other issuers will do what they need to do to protect their turf. Whether it's increases to annual fees that American Express (NYSE: AXP  ) and JPMorgan Chase (NYSE: JPM  ) have instituted or the higher rates that we're seeing across the industry, card issuers will adjust the way they charge for cards to make sure they keep their revenue constant.

That makes it more important than ever to avoid debt trouble in the first place, or to get out of it as quickly as possible. Recent reports show that college students are taking on more debt than ever, and some for-profit educational institutions have gotten in trouble because their borrowers have bad track records in repaying that debt. With home equity no longer a source of funds for struggling borrowers, credit cards remain the last option for many to get cash and pay bills -- and knowing that, issuers can be secure in raising rates without worrying that they'll face much pushback from customers, many of whom have no leverage to fight back at all.

No matter what situation you're in, you can take steps to get rid of crippling debt. Many Fools have taken the debt bull by the horns and come out a winner. But if you keep thinking credit-card companies are on your side, you're going to find it almost impossible to escape -- and the credit-card law won't save you.

Even diehard stock investors are starting to see the benefits of shorting stocks. Read why Matt Koppenheffer thinks short-selling may be the best thing since green eggs and ham.

Fool contributor Dan Caplinger treats debt like any four-letter word. He doesn't own shares of the companies mentioned above. American Express and Discover Financial Services are Motley Fool Inside Value picks. Try any of our Foolish newsletters today, free for 30 days. The Fool's disclosure policy could fit on a credit card and still leave room for a big jester's cap logo.

Read/Post Comments (6) | Recommend This Article (6)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On August 24, 2010, at 1:34 PM, wigginsrl wrote:

    My wife & I have enjoyed a CITI card for five years. We put everything (almost) on it for the convenience of not writing checks. We pay off the balance each month and earn $$ back according the the agreement. In five years we've never paid a cent in interest and gotten hundreds back in cash. Credit card trouble is the fault of personal spending habits, not the credit card.

  • Report this Comment On August 24, 2010, at 2:39 PM, jpwallis01 wrote:

    I agree 100%....too many people live beyond their means and get into trouble with debt. Banks are shysty in the way they accumulate fees at times, but it is the responsibility of the consumer to avoid NSF and over the limit fees. Banks are in the business to make money, they are not our friends. The higher APR's we have on our cards now will greatly out way what little help the CARD act has on the consumer. The act is hurting responsible card users, albeit the few, more so than helping the many irresponsible users. instead of limiting losses on future credit accounts we are just changing way we incur them.

  • Report this Comment On August 24, 2010, at 3:54 PM, ron153 wrote:

    Completely agree. I am not sure why so many people think banks are supposed to loan them money at exceedingly low interest rates, float their overdrafts free of charge, and not impose penalties for late payments. Banks do provide very useful and convenient services, like online banking and overdraft protection for very reasonable prices. Manage your money responsibly and you will not have problems. Pretty simple.

  • Report this Comment On August 24, 2010, at 4:14 PM, guzzo wrote:

    I agree with your advice to pay off all debt and not to play the game. I've been saying essentially the same thing for years, in preparation for this recession.

    But, the increase in student loan debt you mentioned may be due to the fact that tuition in many universities around the country has more than doubled in the the last 5 years, not because of more students being irresponsible.

  • Report this Comment On August 24, 2010, at 4:59 PM, TMFGalagan wrote:

    @guzzo - I completely agree that student loan debt is in a different league from credit card debt and sometimes is a good investment. My main point, though, was that with student loans hanging over you, you're in an even worse position if you start charging up your credit cards.


    dan (TMF Galagan)

  • Report this Comment On August 25, 2010, at 12:36 AM, dgmennie wrote:

    To quzzo and TMGGalagan:

    A recent editorial in the Star Ledger here in NJ(August 18, 2010), took a few easy shots at some "crybaby" Seton Hall law students grumbling publicly about a lack of job offers upon graduation while facing record student loan debt.

    Unfortunately, the Ledger failed to recognize a larger issue. An issue that is currently pitting the bloated Education Establishment everywhere against students and overwhelmed taxpayers.

    The fact is, despite a long-held belief that good grades and college educations are the pathway to career success, we are now seeing that this whole concept has been oversold and oversubscribed regardless of major subject. This means that all the tax money currently going into juiced-up public education and the massive student loans taken on in pursuit of any advanced degree may be (mostly) for naught.

    Frankly, I think it would be far better if public schools concentrated on the basics and dumped the enrichment, special ed, and extracurriculars while being obligated to truthfully advise teens and parents alike about what jobs really exist for someone investing in college. The taking on of huge debt to chase limited or declining "professional" career opportunities depends upon cultivated ignorance plus an overabundance of hype. Most college graduates, regardless of innate talent, are never going to be partners in law firms or ranking players at investment banks no matter what academics they pursue. Thus any implied promise of a six-figure income soon after graduation should be viewed as a lotto prize for the lucky few, not a predictable way for most to repay their crushing student loans.

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