Following an earlier column on consumer debt, I had the opportunity to discuss the subject with a number of people. One of the questions I was asked was particularly enlightening: “In addition to scaling back spending, what else can someone do to better manage their debt?”
My answer: “read all of the terms of your credit agreements, especially those pertaining to interest rate resets.”
The conversation continued when my friend asked: “By credit agreements do you mean the papers I was sent with all of the small print?”
My reply: “That’s exactly what I mean.”
Heading back to this person’s home he opened a drawer full of credit documents. He then pulled out a few for our inspection.
“This one says zero percent interest for the first year.”
“How old is the account?”
“I think I have had it for three years now.”
“What is the interest rate on it now?”
After about five minutes of “small print” reading, my friend had his answer: “It says 25%. How is that possible? With interest rates at such low levels now I just assumed that my interest rate would also be low. I mean, I have not seen interest rates this high since the early eighties. This just isn’t right!”
I empathized with my friend but reminded him that rule number one in finance is to be very careful when making assumptions. Rule number two is to read everything, especially the small print.
Just because interest rates in general are low does not mean that your particular interest rate is also low. Credit providers frequently offer low teaser rates because they know such rates will attract customers. They also know that most customers do not read their credit agreements, especially the small print, and as a result those customers will not react when their teaser rates reset at higher levels.
One way to manage the risk of things like this happening is to keep a running list of all your credit lines. The list could include recording information such as: the name of credit providers, the date each account was opened, credit amounts, initial interest rates, reset provisions, late payment penalty provisions, etc.
With information like this you can do a variety of things to better manage your credit. For example, prior to any reset you can call your credit provider and let them know that you are considering closing the account if the “teaser rate” is not continued, or unless some other accommodation is made. Alternatively, you can simply take advantage of other low teaser rates by rolling over credit balances prior to any scheduled resets.
A word of caution here: A key assumption with strategies like these is that your credit balances can be refinanced at rates that are lower than impending reset rates. Such assumptions have generally been valid since 1981 due to generally declining interest rates since that time.
However, a growing number of successful professional investors are cautioning that the downward trend in interest rates is at risk of reversing. Like all prices, interest rates can go up as well down, and have done so for hundreds of years.
If interest rates in general do begin to steadily move higher, implementing credit strategies like those profiled above will become increasingly difficult. Therefore, such strategies should be used as part of a program to manage credit balances down over time. They should not be used to fund increased levels of discretionary spending.
How to read the fine print: Act Now