The six major Canadian chartered banks and other financial institutions are well aware of Canadians’ extensive use of VISA and MasterCard (MC) credit cards. According to the latest statistics published by the Canadian Bankers Association, not only the number of these cards in circulation has mushroomed from 13 million in 1984 to 72 million by 2014, the number of issuers of these cards has also jumped from 10 to 28. In 2014, there were 15 principal issuers of MCs and 13 of VISA cards.
Subsequently, the number of merchant outlets, accepting VISA and/or MC has increased 3.4 times – from 442,928 in 1984 to 1,485,147 in 2014. And, the gross sales slips issued by these merchants have sky-rocketed from 325.2 million to 3,675.6 million – an increase of 11.3 times compared to an increase of 1.5 times in the potential number of credit card users, i.e., the population 18+ (18.9 million to 28.6 million). This translates into 128 gross sales slips processed per person in 2014 compared to 17 in 1984 (Chart 1).
The net dollar value of transactions on these cards (including cash advances) has risen from $17.10 billion in 1984 to $399.23 billion by 2014 – a 23-fold increase. Since money owed on credit cards is a part of consumer debt, no wonder, Canadians are increasing their overall consumer debt, as reported periodically, by both Statistics Canada and the Bank of Canada. Canadians seem to be in love with their credit cards. They likely use these not only to purchase goods and services, but also for convenient travel, bill payments, shopping on phone, and above all, for shopping online. The continuing growth of e-commerce is one of the key factors pushing the use of credit cards.
Sensible use of credit cards
It’s not bad to use credit cards (as a convenient and handy source of payment for any purchase in-person, or online) as long as users can repay their full balances each month. If that were the case, users won’t pay any interest to issuers, who will still make money on commissions charged to merchants selling goods on credit cards. But the reality is different. A good proportion of these card users carry-over monthly balances, likely because they don’t have sufficient funds to fully pay off their accounts, on interest rates as high as 20+%. These balances accumulate over time, putting these users deeper and deeper in the hole. These users constitute the most financially vulnerable group. Of any payment they make, a good portion of it will likely cover the interest charges. And, if they are making just the minimum payment, then almost the entire amount is simply covering the interest charges. Interest paid by these users is all that institutions need to solidify their revenue base. Those who pay off in full each month hardly contribute to this base (other than paying their annual card fee – which, again, varies with the type of card they carry). Since the interest on loans and credit cards is one of the key sources of revenue of issuers, they want to keep this financially vulnerable group as well as their peers around by further offering them various incentives, including the reduced monthly payment, periodic increases in their credit limits, allowing them to skip a payment with full interest charged – to name a few. Because it’s the interest income from this group that’s supporting other customers’ free air travel, variety of insurances, car rentals, ad-hoc rebates, cash-back programs, etc. In other words, this group is helping issuers not only to keep their other customers happy, but also in expanding their businesses.
Card issuers are not to be blamed
To be fair to card issuers, the truth be told. We live in a democratic and free-market system. Issuers are not forcing anyone to use their credit cards. It’s the user and his/her vulnerability, financial needs, impulsive shopping habits, inability to postpone a purchase, or some personal urgency, that may make him/her to use a credit card – that, too, of his/her own choice. Issuers of cards are there in the market, selling ‘money as a good at a cost’ to customers in need of their product. Issuers have to protect their money against any risk as well as earn a decent return by charging interest. On the other hand, users have the responsibility to weigh the pros and cons of using credit cards to finance their spending habits. They need to ensure about their ability to handle credit well, and within their affordability. The onus is strictly on a user to pay in full or carry-over the monthly balance. He/she doesn’t want to be labelled as ‘delinquent’, or ultimately ‘bankrupt’ (I will be writing a separate note on personal bankruptcies).
90-Day delinquency rate
The financial institutions define the fiscal year-end ’90-day delinquency rate’ as the ratio of the number of overdue accounts for 90 days expressed as a percentage of all accounts. So a user who is making just the minimum payment monthly is not a delinquent even though he/she isn’t paying any principal. No wonder, the 90-day delinquency rate has been around 1% or less with the exception of fiscal year 1990, when the rate jumped to its highest value of 1.8% (Chart 2). Keep in mind that the Canadian economy experienced a mild recession over the 1990-91 period. During the recession, those people who lose jobs and have no savings to rely on, usually depend on borrowed money – as a bridging measure. Another spike in delinquency rate of 1.3% can be noted for 2009, year when the economy just began to turn around after the recession – from late 2007 to early 2009. Technically, users who can’t pay a portion of balance outstanding should be treated as delinquent. But since the institutions care only for their interest income, they are not bothered about the time such users will take to repay their balances outstanding. Institutions simply remind users each month the time (in years and months) it will take to repay the balance if they kept paying only the minimum payment.
What’s this minimum monthly payment?
This payment is the interest charged on the outstanding balance from the previous month plus ten dollars. Even though there are lots of calculators available on the Google site for users to calculate their monthly payment for a given amount outstanding, at a given interest rate, I am simply illustrating a case for the benefit of my readers.
Say, one owes $5,000 at 13.99% interest rate. The interest is charged daily. So the first thing to do is divide 13.99% by 365. This gives us a daily rate of 0.0383%. Now if one’s statement period covers 30 days (as usually shown on the monthly statement), then the monthly interest charged is: (5000×0.0383×30)/100 = $57.45. Add $10 to this, and you have a minimum payment of $67.45. So if one pays this amount only, then it is evident that one is simply paying the interest charge on $5,000, and just about $9 or so to pay off the balance outstanding. At this rate, a user will take closer to 500 months (or 41 years and 7 months) to pay off $5,000. That’s what the card company writes as a reminder on its monthly statement. For $10,000 balance, it will be close to 1,000 months (or 83 years and 3 months). The inclusion of this reminder, along with the rate of interest being charged on the balance outstanding, in a monthly credit card statement is mandatory in Canada. Its objective is to remind and persuade users to pay more than the monthly minimum to pay off the balance quicker.
Simply making the minimum monthly payment will leave the card user in debt forever.
Tags: VISA/MASTERCARD Credit cards Consumer debt
Minimum payment Interest on credit cards