Anya Kamenetz Generation Debt

Did you know that the global economy could hinge on your maxed-out MasterCard?

As we hit the height of the holiday season, 'tis the time to shop. And consumer spending as a whole drives about 70 percent of the U.S. economy. But that engine is threatening to stall out.

For those of you who haven't been reading the business pages, here's a recap: U.S. housing prices, after rising like mad for nearly a decade, have gone into a slump. In turn, the value of mortgage-backed securities, a financial innovation that traded intensely during the housing boom, has been called into question.

Now, world financial markets are hitting a bigger credit crunch. Businesses and banks are having trouble borrowing the money they need to grow, because the banks and investors they borrowed from are not confident they will be paid back.

That same "liquidity squeeze" may bedevil the American shopper, too. Real median income has not gone up since 1999, but between 1995 and 2005, Americans borrowed and spent more and more money each year against the value of their homes -- up to an astonishing $1.4 trillion in 2005.

Often, they spent and borrowed on credit cards, and then got a home-equity loan or line of credit to pay off the plastic. Now that well is running dry as home prices fall. So as national banks are hitting a credit squeeze, Americans' ability to consistently increase spending -- regardless of income -- is in danger of being cut off.

Why should you, a young person who most likely has no mortgage, give a fig? Because this is an excellent time to stop overspending on your credit cards. Young people have a once-in-a-lifetime chance to do better than our elders when it comes to debt, if we just open our eyes and learn from what's going on now. 

On Dec. 4, Senator Carl Levin (D-MI) held the second in a series of subcommittee hearings on questionable credit card industry practices. The hearing contained vital information that anyone with credit cards should be aware of. After reading this column, I hope you'll be motivated to pay off your cards -- and keep them paid off.

The Mystery Number

Do you know the score? Credit card interest rates are based on your FICO score. A good FICO score is one that is above 700. But it's hard to know in advance how specific actions will impact your FICO score.

For example, let's say you open a couple of department store cards. If you had very little credit before and you don't charge too much on the cards, the new accounts could raise your score. If you had lots of credit already, the new accounts could lower your score. Or if you spend close to the limit -- without going over -- on any one of your cards, your FICO score could drop and the interest rate on all of your cards could change. 

Remember, if you're young, you have a shorter credit history, so any one action could have an outsized impact on your credit score.

Interest Rates: Gotcha!

Credit card companies can increase your interest rates, termed APR (Annual Percentage Rate), whenever you make a mistake or fall behind on a payment -- from your student loans to your car. This process, called universal default, is often automated, arbitrary, and opaque.

Levin's hearing presented the records of a Michigan nurse named Janet Hard. Ms. Hard had always paid her Discover card bills on time, never exceeded her credit limit, and always paid at least the minimum amount due. In 2006, out of the blue, Discover increased the interest rate on her card from 18 percent to 24 percent. When Senate investigators looked at her credit history, they could find only one possible reason -- a single late payment on a JC Penney account.

This is my favorite one: Credit card companies can also increase interest rates on cards that they determine are "below market." Capital One, for example, doesn't use universal default. Instead, they go through their accounts and automatically raise rates if they have been fixed for a couple of years. Oops, we were giving you a good deal -- sorry about that!

Interest rate increases can be retroactive. They apply to balances you already carry. You also pay interest on fees and penalties that are added to your account. If your interest rate goes up but you continue making the same monthly payment, the amount that actually goes to reduce the debt shrinks into insignificance. In the Janet Hard example, she paid $200 a month -- $2,400 in a year -- on an $8,300 debt. But only $350 of that $2,400 actually reduced the debt.

Get on that treadmill and you'll be a grandma (or grandpa) before you get off.

Cold-Case Files

Credit card companies can raise your interest rates on cards that have been closed for years. The hearing covered the case of one retiree who had an account that he was paying off faithfully every month and making no new charges on. But his interest rate was automatically hiked from 15 percent to 27 percent because his FICO score had dropped.

Here are some more not-so-fun facts about credit card industry practices:

You're Late!

Credit card companies can require payments to arrive between 10 a.m. and noon on the day they're due. Or they can change your due date. In the fine print of their standard agreements, most credit card companies reserve the right to change terms like these at "any time for any reason," although some companies have done away with that practice.

The Phantom Fee

According to a March NPR interview with Elizabeth Warren, a Harvard Law professor and expert on credit cards, one company apparently charged a $75 fee to all customers. For anyone who was alert enough to call and complain, the fee was removed. But there were likely many customers who did not realize the fee was assessed -- and thus were $75 poorer without even knowing it. 

With all of this said, credit cards are a reality for most of us. They can provide convenience, are a good backup for emergencies, and are one important way to build a good credit score, if used correctly. So how should financial novices handle credit cards in a world where all bets are off?

1.) Shop around for a card. You want a card with a 15 percent APR or less, no annual fees, and no universal default. Watch out for low teaser rates that go up to 20 percent after 90 days.

2.) Pay your bills online. Ideally, you'll set it up to pay off the entire balance a few days before the due date, to avoid getting hit with sneaky late fees. Short of that, pay well over the minimum payment when you can. But...

3.) Don't just pay the same amount each month automatically. If your APR goes up, the amount you owe may be retroactively increased. Here come the over-the-limit fees, late fees, penalties, and interest rate increases. So you must...

4.) Check your statements carefully every month, especially your interest rate, penalties, and fees.

5.) Get your credit report a few times a year. You need to check your FICO score to determine how lenders see you as a risk and whether your interest rates are in danger of increasing. Here's how to read your credit report.

6.) Negotiate your interest rates and fees with credit card companies. If you see an increase, call them up and ask for a better rate. You can get leverage by threatening to close your account and switch to a new card.

Find more credit card tips here and here.  

It takes time to pay off debt, and I know it's not easy, especially when it comes to expenses such as housing and health care. But you can avoid all finance charges and hassles by gradually paying down your cards and limiting your use of the almighty plastic.

You have a choice about whether or not you will be at the mercy of the credit card companies.