Talking to your credit card company

From the September 2 edition of Your Money Today on KWAV 97FM.

If you are struggling with consumer debt, the last thing you probably want to do is talk to those nice people at your credit card company.  But your card company's collections manager may be in a great position to help you.

Many people are surprised when I tell them they can actually negotiate with their credit card company. It seems so pointless. After all, you owe them money--maybe big money. Why would they want to talk with you? Because credit card companies are experiencing big problems. Huge numbers of loans are in default. If you can help them avoid one more default, most will welcome a conversation. The key is to know how to talk with them.

You need to remember that your credit card company is not in business to do you any favors. Like every other business, they go to work every day to make a profit. So if you want to renegotiate your debt, you need to approach it from a business point of view and that means you first need to understand how they make money.

How credit card companies make money

Credit card profits are powered by four engines:

  1. Interest income: Credit card companies raise capital at a low effective cost and lend it to you at a much higher interest rate. They make money on the difference.

  2. Intercharge fees: Everytime you buy something on a credit card, the merchant who accepted the card pays a fee. Fee's typically range between 1 and 4 percent. About 85% of the fee goes to the issuing bank and the rest goes to Visa or Mastercard and the credit card processor.

  3. Cardholder fees: Depending on your payment habits and your card, you may be paying all sorts of fees in addition to interest and finance charges. Some of the most noteworthy include membership fees, late-payment fees, over-limit fees, and balance transfer fees

  4. Selling your information to third parties. Ever wonder where all that junk mail comes from?

These four engines work very well when times are good. That's why you get so many unsolicited offers for credit cards in the mail. But when times are bad, these engines sputter and stall. Right now, times are very bad.

Trouble in paradise

When everything is running smoothly, the credit card business is easy. But consider what happens when people stop paying their bills. Very quickly, the profit engines lose power. Revenues go into free fall, but expenses continue to mount including the cost of the capital, corporate overhead, and any costs associated with trying to collect on the defaulted loan.

If a small percentage of borrowers do this, it's no big deal. Card companies anticipate that a small percentage of their loans will go bad every year. It's a cost of doing business. But when default rates spike higher -- and they always do in recessions -- card companies feel the pain. We are in the middle of the worst recession in 70 years and, according to Fitch Ratings, credit card charge-offs peaked at 10.8 percent in June, the highest in more than 20 years. That's a lot of pain.

When a loan goes bad, the card company has several options all of which are expensive for the card company and unpleasant for the borrower.  It is much better for the credit card company to find a way to keep the borrower paying on the loan. And this is the source of your opportunity.

Do your homework

Before you call your credit card company, you need to do your homework. Don't try to skip this part. The lazy person will try to just call them up and see if they can get some sort of a deal. Don't be lazy. Credit card companies are hurting, but they aren't stupid and they will know if you are trying to pull something over on them. They have been at this game for a long, long time and they can spot phonies from a mile away. By doing your homework, you will convey to the collections manager that you know what you're talking about and that you can be trusted.

Your homework consists of finding out how much you can afford to pay on a monthly basis. Start by taking a sheet of paper and listing your monthly income at the top of the page and your essential expenses at the bottom. Be sure you only write down your essential expenses at this point. Essential expenses include housing, medical, transportation, food, utilities, etc. Getting your dog bathed at the local pet groomers is not an essential expense and, for the purpose of this exercise, neither is your credit card payment. We will get to your credit card in justa moment. Now, subtract the total essential expenses from the total income. The money you have left over each month is called your discretionary income. 

Next, list out your credit card debts including outstanding balances and minimum monthly payments. The ratio of your minimum monthly payment to your discretionary income is called your discretionary debt payment ratio.Your goal is to get your discretionary debt payment ratio below 30%.

The 30% Rule

You may ask, why 30%? Because with a discretionary debt payment ratio of 30% or less, you have a very high likelihood of being able to make your minimum monthly payment even if unexpected troubles arise. When you talk to the collections manager at your credit card company, you want him to know that you are someone he can do business with--someone he can trust. You want him to feel that any deal you negotiate is rock solid. The 30 percent rule gives you the ability to make such a commitment.

An example from the typical American family

An example will help clarify how this works. Suppose you are a "typical" American family earning about $50,000 a year. With a combined state and federal tax rate of 25%, this means your average monthly take home pay is about $3,100.  After total essential expenses (rent/mortgage, car payments, groceries, utilities, etc.) of $2,5000, you have $600 in monthly discretionary income. Based on our 30% rule, your total minimum monthly payment should be $200 or less.

Since you are a "typical" American Family, we know you have about $9,000 in credit card debt. And sincemost credit card companies set minimum monthly payments equal to 4% of the outstanding balance, we can surmise that your minimum monthly payment is about $360, or $160 more than our 30% rule would allow. We need your credit card company to do one of two things:

  1. Reduce your balance to $5,000 (the level that would result in a $200 minimum monthly payment), or

  2. Reduce your minimum monthly payment to $200.

Your bargaining position for a reduction in your minimum monthly payment is strengthened because a $200 minimum payment is 2.2% of the outstanding balance. Until earlier this year most credit card companies set minimum payments equal to 2% of the outstanding balance. Your new level is still higher than the standard they followed a few short months ago.

If you are in really bad shape, you will do well to acknowledge the fact to yourself and the card company. If you are so over borrowed that you simply can't make it, put together a clear analysis of how much debt you can support and see if they can work with you to reduce the amount you owe. It used to be that card companies would never forgive part of a loan. Over the past year or so, some card companies have become much more amenable to this sort of thing. It's amazing how stiff loan losses can change entrenched thinking.

Another angle to try to negotiate is your interest rate. If you have a good payment history, and good credit, they may be willing to do something for you.

Other considerations

As you talk with your credit card company, try to keep in mind a few other important points:

First, just because you make a good case does not mean the credit card company will see it your way. Remember, this is a negotiation, so don't expect to dictate terms.

Second, you may need to talk to several people at the card company before you find the person who is able and willing to make a decision on your case. Generally, the person who first answers the phone is not the person with the proper authority so don't overwhelm them with details. Explain enough to help them know what you want and see if they can help you get to the right person. The right person will usually be up in the organization a level or two.

Third, remember that the purpose of your call is to help you get in position to pay down your debt. If you get relief on the size of your monthly payment or a reduction in you interest rate, use the relief to help yourself structure your snowball debt strategy more effectively. If you are able to get a reduction in the balance outstanding, use it as a spur to motivate you to pay off the remaining balance even faster. No matter the outcome of your call, the end goal does not change: pay off your debt and get your financial life back on track.

Fourth, if you succeed in having some of you credit card debt cancelled, you will likely have to pay tax on the amount that is cancelled. The issues around this can be very subtle, so make sure you talk with a tax advisor.

Finally -- and this is REALLY IMPORTANT -- remember the guy on the other end of the phone is not your friend. He is there to make his company money and he may not be someone you can trust. You do not have a deal until you get it in writing. Do not assume you have a deal until you get it writing and do not agree to send them any money other than your normal minimum payment UNTIL YOU GET YOUR DEAL IN WRITING. Hopefully, I've been clear on this last point.

Conclusion

The key to talking with your credit card company is to approach them with a solution that makes sense from a business perspective. They want to see you succeed because it means they will succeed. But don't fool yourself into believing they will give you what you want just be cause they are good and kind. They will work with you if it works for them. So appeal to their self interest and cut yourself the very best deal you can. By doing your homework ahead of time, you will maximize the likelihood of getting a deal that works for both of you.