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Saturday, August 29, 2009

Credit Card Companies, Friend or Foe?

Have you ever wondered exactly how credit card issuers stay in business? The credit card companies mail an approximate 4 billion solicitations each year. Despite the fact that they come in different colors and sizes they all have one thing in common. They are all trying to convince you to apply for one of their credit cards. Depending on what source you believe, the industry will mail between 16 and 20 times to each credit-qualified consumer in the United States. In layman’s terms this means each of us gets, on average, sixteen to twenty pieces of mail annually from credit card companies trying to convince us to apply.

The response rate of these mailings, also known as “pre-approval” mailings, is abysmal. The industry averages no more than a 0.6% response rate. And, of the 0.6% who respond, fewer will actually ever open and use the account that they’ve applied for. And, of those few who do open an account, even fewer will actually revolve a balance from one month to the next. And, of those who do revolve a balance, fewer still will actually pay their bills on time. So, again, the questions is…how do these companies stay in business?

Don’t be swayed by the pessimistic tone of the introduction. These companies make piles and piles of cash from their credit card portfolios. So, please put away your checkbooks and stop thinking of sending your charitable contribution to Delaware and South Dakota, where most of the large credit card issuers are based because of favorable state laws.

The problem is that none of them have figured out what to say, how to say it or what kind of envelope to put it in to convince us to apply for their wares more than 6 times out of every thousand envelopes they mail. For every 1,000,000 pieces of mail they will get 6,000 responses. If only 80% of those responders actually open and use an account then that’s 4,800 new accounts. If each of those new accounts generates only $30 each month in interest (a very reasonable amount) then that’s $144,000 each month or $1.73 million dollars per year. Now you’re getting the picture on how these companies stay in business. And, to boot, 1,000,000 pieces of mail is nothing for the large credit card issuers who will send out several hundred million solicitations this year.

Once you are on their books as a customer the fun really begins. They love you when they are trying to get your business but you will eventually lose your luster. You are no longer the flavor of the month. You are now a living breathing profit center to them. And they’ve figured out plenty of ways to separate you from your hard earned dollar. Further, they’ve managed to self justify the means almost as to seem normal. Here are the most common ways credit card issuers will make money from you once you’ve started using their cards.

So, Friend or Foe? A compelling argument can be made for each side of the debate.

Friend — The credit card environment in the U.S. is more inviting than any other country. The reality is that pretty much anyone can get a credit card. In other countries the protocol calls for saving your money and paying cash for your belongings. In this country as long as you have a salary and a decent credit rating you can buy a car and a home complete with furnishings all using someone else’s money.

Foe — Opponents will counter that the credit card issuers are allowed too much leeway to aggressively market. This has lead to predatory lending practices from unscrupulous lenders and an increase in amount of household credit card debt. There are also too many offers targeted specifically to new credit users, typically students, who end up entering the workforce in severe debt and close to bankruptcy.

You can also make a good argument that without a credit card you can’t function efficiently in today’s environment. This can be a pro or a con. You can’t rent a car, check out a movie, buy anything online or reserve a hotel room. You have to have a credit card to function today. It’s that simple.

The bottom line is that credit cards are what you make of them. If you let them, they can easily overwhelm you. However, if properly managed then credit cards can be your friend and ally in accumulating wealth and security…all while using someone else’s money.
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