Millions of people with credit cards will soon have to pay more each month. This is both good and bad news for consumers.
In general, the minimum monthly payments for credit card debt will go up in January because of new rules suggested by the federal government. Many mortgage lenders won't ask for payments equal to 2% of the debt, which includes interest and fees. Instead, most will now ask for a payment equal to 1 percent of the debt plus fees, interest, and charges. Most of the time, the new payment will add up to more than 2% of the borrower's total debt.
The good news is that. By making people pay more each month, the higher payments will lower overall interest costs and make people less likely to borrow with credit cards.
Worse news? It will make it harder for many people to get a mortgage.
The most recent report from the Federal Reserve shows that we now owe $799.1 billion in credit card debt. This works out to about $2,681.54 per person: The average amount of credit card debt for a family of four is almost $10,750.
This kind of debt wouldn't be a problem if it was matched by just as strong savings. The Bureau of Economic Analysis says that in both October and November, we saved less than 2% of what we made. Instead of putting money away, we spent $37.4 billion more than we made in just those two months.
Credit card financing is unsecured debt, which is a type of loan that mortgage lenders tend to avoid because it is risky. More risk means higher interest rates, and everyone knows that credit card interest rates range from 18 to 28 percent.
Let's say a family owes $10,000 on their credit cards. Imagine that the interest rate is a reasonable 18 percent and that you have to pay back 2 of the total amount owed each month. If you didn't take out any more money, it would take 7.8 years to pay back this loan, and the interest would add up to $8,622. If the monthly payment was raised to 4 percent, the same debt could be paid off in 2.7 years and the interest would be $2,628. This would be a big savings of almost $6,000, which is a lot of money.
Millions of people will have less credit card debt because of the new rules for paying off credit cards, but the higher minimum payments will also affect mortgage applications.
When mortgage lenders look at loan applications, they think about a lot of things that have to do with money. It's important to know how much borrowers spend each month, which can be broken down into two main categories: housing costs and consumer costs.
"PITI," which is a term used by lenders, stands for mortgage interest and principal, property taxes, and insurance. Consumer costs include PITI and things like credit card bills, car payments, student loan payments, etc. that have to be paid every month.
Costs are shown as a percentage of a person's monthly income. If your family makes $8,000 a month and your PITI costs $2,240 a month, your "front" ratio is 28%. If the total amount needed to be spent is $2,880, then the "back" ratio is 36%. Lenders would say that the ratios are "28/36" as a whole.
In fact, you need to meet certain front and back ratios to be eligible for certain mortgage loan programmes. Different loan programmes have different ratios, so if you don't qualify for one, you might still qualify for another. For example, the ratios for traditional loans (28/36), FHA loans (29/41) and VA loans (effectively 41/41) are all different. Adjustable-rate mortgages often use 33/38 ratios, while other loans have even looser requirements, with some having a back ratio of over 50.
Now, go back to the new rules for how credit cards can be used to pay. If your monthly payment goes from $200 to $280, that's good because it helps you pay down your credit card debt, but it also means that your monthly payment has gone up. For example, a person's monthly costs might go from $2,880 to $2,960. No big deal when it comes to money or the cost of living for a family of four with a monthly income of $8,000, but now the "back" ratio is 37%.
Whoops. Because of that higher credit card payment, some people won't be able to get certain mortgages. They spend more than they should each month.
What to do?
First, you should realise that paying high-cost, non-tax-deductible credit card charges is not a magic way to get rich. Cut down on credit card use to get the best mortgage possible and just save more money.
- Check your credit score and get rid of any credit cards you don't use or need. Keep one for emergencies.
Talk to the underwriters. Ask if there is a way to get a "break" from the rules.
- Use debit cards instead of credit cards. With a debit card, you just use the money in your checking account. When you pay with cash instead of credit, you tend to buy less.
- If you have credit cards, you should always pay them off in full and on time, and keep the balance at $0.00.
- Start saving. People save a lot of money by doing simple things like putting aside all the single bills and coins they find in their wallet at the end of the day. Eat at home more, bring your lunch to work, keep your car in good shape for longer, and spend less on fashion and extras.
- Get a line of credit (overdraft protection) for your checking account or link your savings account to your checking account. Both of these things can help you avoid overdrafts and extra fees.
So, the next time you pull out your credit card, think about what you really want: a new sweater or a new fireplace, a fancy dinner or a better kitchen, higher monthly payments or less. In no time, it will be easy to not see or think about the plastic.
