The Perils of Plastic
Below is a MRR and PLR article in category Finance -> subcategory Mortgage.
The Perils of Plastic
Overview
Millions of credit card holders are on the brink of experiencing higher monthly payments. This development presents a mix of opportunities and challenges for consumers.
New Payment Standards
Beginning in January, new federal guidelines will increase the minimum monthly payments for credit card debt. Previously, payments were around 2% of the debt, inclusive of interest and fees. Now, most lenders require a payment of 1% of the debt plus interest, fees, and charges, often exceeding the former 2% standard.
The Good News
These increased payments will help consumers save on interest and encourage less borrowing via credit cards.
The Bad News
Higher payments can hinder many from qualifying for mortgages due to tighter budget constraints.
The Bigger Picture
The Federal Reserve's latest data shows that U.S. credit card debt stands at $799.1 billion, averaging $2,681 per person. For a family of four, this amounts to nearly $10,750 in debt. Unfortunately, this is not offset by savings, with the Bureau of Economic Analysis reporting a negative savings rate in recent months, highlighting a trend of overspending.
Credit card debt, being unsecured, poses significant risks for mortgage lenders, often leading to interest rates between 18-28%.
A Closer Look
Consider a family with $10,000 in credit card debt at an 18% interest rate. A 2% monthly repayment schedule would take about 7.8 years to clear the debt, costing $8,622 in interest. However, doubling the payment percentage to 4% could reduce the repayment period to 2.7 years, saving nearly $6,000 in interest.
While the new standards aim to alleviate credit card debt, they complicate mortgage applications. Lenders evaluate financial health by considering housing and consumer expenses as percentages of income. Here’s how this plays out:
- Housing Expenses: Mortgage interest, principal, property taxes, insurance.
- Consumer Expenses: Includes the above plus credit card, auto, and student loan payments.
For example, with a household income of $8,000, monthly housing expenses at $2,240 represent a 28% "front" ratio. If total expenses reach $2,880, the "back" ratio is 36%. Mortgages often require specific front and back ratios, and if credit card payments increase?"say from $200 to $280?"the back ratio may rise to 37%, disqualifying potential borrowers from certain loans.
Steps to Take
1. Reduce Credit Card Use: Paying high-interest, non-deductible credit card charges does not build wealth. Minimize credit card reliance to better qualify for mortgages and save money.
2. Evaluate Your Credit Needs: Cancel unnecessary credit cards, keeping one for emergencies.
3. Consult Underwriters: Ask about potential exceptions to mortgage guidelines.
4. Commit to Saving: Develop simple saving habits like setting aside single bills or coins, eating in more often, and reducing luxury expenses.
5. Maintain Good Credit Practices: Always make full and timely credit card payments to maintain a zero balance.
6. Opt for Debit Cards: Using a debit card ensures spending is limited to available funds, reducing impulsive purchases.
7. Get Overdraft Protection: Link savings accounts to checking accounts to prevent overdraft fees.
When considering a credit card purchase, weigh what's more important: a new item or long-term financial flexibility. Keeping spending in check will help achieve financial goals without the weight of excessive debt.
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