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Credit Card Scams Part II: Reverse Payment Prioritization

June 17, 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

Related posts:

1. Credit Card Scams Part III: The Balance Transfer Scam
2. Credit Card Scams Part I: Debt Collection Practices
3. Credit Card Scams Part IV: The Penalty Rate Scam
4. Exploiting Ignorance: Money for Nothing
5. Credit Cards & Responsibility

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Posted in: Economics Lessons, Legalese, personal finance

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