Credit card companies allow card holders to pay a minimum payment—a set percentage.   This makes the payment more affordable but ultimately allows the credit card company to collect huge amounts of interest

Congress recently passed the Credit Cardholders’ Bill of Rights Act of 2009 to protect consumers against unfair interest rate changes and fees.  Five out of 99 attending senators voted against the bill, and four did not vote.  Two of the five “Nays” were from South Dakota, the state where most credit card companies are headquartered due to the state’s lack of a statutory limitation on credit card interest rates and other favorable conditions.  A few days after the vote, Pres. Obama signed the Credit Card Accountability, Responsibility, and Disclosure (CARD) Act of 2009.

Still, some call for legislation forcing credit card companies to increase the minimum to 5%  to protect consumers from excessive interest.  Chase Bank has voluntarily raised its minimum payment requirement from 2% to 5% on certain cards.  This increase causes difficulty for those who cannot afford the new payments; many pundits are framing Chase Bank’s action as consumer abuse, but it’s actually the prudent thing to do.  In the long run, it will keep consumers’ interest charges from growing out of control.

There is a key relationship between the interest rate and the minimum payment.  For example, at 19.5%*, the effective monthly interest rate is 1.496%.  Compared to a minimum payment of 1.500%, this means that almost none of the payment is applied to the initial $10,000, as shown in the graphic.  Interest adds up at almost exactly the same pace you pay it down meaning that it would take about 5,000 years.

*Interest calculated using an average daily balance method with monthly compounding.

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Captions:
(1) Enter some personal information in an application and send it to the credit card company.

(2) The card issuer will estimate your ability to pay back money, and send you a credit card with a limit that they determine.

(3) You can make purchases until you reach the credit limit.

(4) The card issuer will send a monthly bill that shows how much you spent.

(5) You will have a set number of days (the “grace period”) to make a payment. You will be charged fees if you miss a payment deadline.

(6) A – Pay only a small portion of the balance each month, and interest charges will quickly pile up.
B – Pay the full balance each month, and it’s a free loan.

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