OCTOBER 2005 :: CONSUMER ED

Card Tricks

New Bankruptcy Law Makes It Even More Important to Manage Your Debt Wisely

By Karen Blumenthal
Staff Reporter of The Wall Street Journal

For people who get carried away with spending and find themselves deep in debt, filing for bankruptcy can offer a fresh start. But starting in October, a new federal law will make it much harder for borrowers to wipe away their debts.

Why does this matter to you?

Because it means that the seemingly little choices you make when you're on your own for the first time can snowball-and they can haunt you for a very long time.

Take credit cards. From the time you turn 18-or earlier, if you already have a checking account-banks will offer you an endless stream of cards, from those promoting your college or favorite team to those promising low interest rates and fees. Credit is a handy thing, since it can help you pay for emergencies like a big medical bill or car repair or give you a chance to pay off a big purchase, like your college textbooks, over a couple of months.

The problem is that credit is so simple to use and so invisible that it's easy to run up bigger bills than you can afford to pay. James A. Roberts, an associate professor of marketing at Baylor University in Waco, Texas, has studied compulsive spending among college students and calls credit cards a "spending facilitator."

He notes that with cash, it's impossible to spend more than you actually have, and it's tricky-not to mention illegal-to write a check for more than is in your checking account. But "what we've found is the money involved in credit cards is somewhat abstract," he says. In fact, a study of students leaving the school bookstore found that students who paid with cash or check knew pretty much what they had spent. But, he says, those who paid by credit card tended to be off by as much as 60%.

The way credit cards work compounds the problem. Banks may allow you to make only a minimum payment of $10 or $15 each month, even if you owe several hundred dollars. But you'll pay interest at an annul rate of 17% or more on the balance.

Your debt can really balloon if you make a monthly payment after the due date or miss the deadline altogether. The student Visa card from Bank of America, for example, will assess a $29 fee if you pay late on a bill of $100-and you'll pay interest on top of that. If you miss a payment or are late, the bank can raise your interest rate far higher.

So it's no wonder that credit-card debt is one of the main reasons that young people file for bankruptcy protection. Those who finish college with both student loans and large credit-card debts may find themselves particularly vulnerable to a financial crisis, especially if they face an unexpected challenge, like a large medical bill.

Here are ways to keep your debts from becoming unmanageable:

Keep track. Just a few years ago, credit-card users had to wait for the bill every month to see how much they owed. But online banking lets you track exactly how much you've been charging over the course of the month, so you can plan how you'll pay for it.

More students do seem to be paying attention to the risks. A study by student-loan provider Nellie Mae, released earlier this year, found that 76% of all college undergraduates had at least one credit card, down from 83% in 2001. Most got their first card as freshmen. The average student with credit cards owed $2,169 on them, a hefty amount, but down $158 from Nellie Mae's 2001 study. More than half the students owed less than $1,000.

Pay off your debt before it balloons. Try to pay the full amount on your card each month, but if you can't, pay as much as you can-not just the minimum. If you need to pay off one big purchase over time, stop charging new purchases until you can reduce your debt.

And whatever it takes, pay on time. Late payments not only cost you in late fees, but also can hurt your credit rating. A series of late payments or a debt that is turned over to a collection agency could stay on your record for up to seven years, affecting your ability to get a car loan, sign up for a cellphone, rent an apartment or even get a job. "That's a long time for someone who's 21 years old," says Michael E. Staten, director of the Credit Research Center at Georgetown University's McDonough School of Business.

If you get in trouble, get help before you're under water. Many college campuses have financial counseling services, and many communities have nonprofit Consumer Credit Counseling Services that will help you work out a plan to pay off your debts.

As of this year, you can inspect your credit report once a year free of charge. Mr. Staten says it's a good idea to check annually to be sure the information on your report is accurate.

Bankruptcy is a last resort. A recent study found that the number of bankruptcy filings by people under age 25 grew 50% during the 1990s, to about 7% of all filings.

Most people who file for bankruptcy protection usually end up surrendering nearly all their assets, including cars, jewelry and other valuable possessions, in exchange for a deal that eliminates their debts entirely.

But under the new law, those who earn at least the median income in their state and who have the ability to pay back some of their debts must work out a plan to continue paying creditors rather than having the slate wiped clean.

Mr. Staten says a bankruptcy filing will stay on your credit record for 10 years.

For an archive of Consumer Ed columns, visit http://wsjclassroom.com/consumered.