The Real Costs of Credit Cards
Credit card companies want us to believe that the reason credit card
interest rates and fees are too high is that the silly consumer just doesn't want to shop for cheaper credit.
The truth is very different. Those beautifully printed
solicitations for credit cards that are everywhere these days almost never give
you all, or even most, of the information you need to make a rational choice of one card over another.
Annual fees, interest rates, grace periods, cash advance charges, late
fees, over limit fees, account closing fees, fees piled on fees piled on
fees-all these are rarely mentioned on those beautiful applications.
The credit card companies just do not want to tell the customers about
prices. Indeed, only when Congressman Charles Schumer of New
York introduced and passed a bill in 1988 requiring the card
companies to put what's called the Schumer Box (which discloses the annual
fee, interest rate, and a few other vital items) on most of the credit card
companies' solicitations and applications could the consumer figure
out what some of the costs of using a card would be without actually applying for it, sight unseen.
How could anyone have compared card costs when it was
impossible to find out what the card costs were? The card companies liked it
that way. It helped fatten company profits no end. That's why they
fought so hard against Congressman Schumer's disclosure efforts.
It used to be that only after your application had been accepted did the card
company have to tell you what it was going to charge you for the card, and then
only in itsy-bitsy almost unreadable type. After
you applied for a credit card it was too late to compare prices. That is why the
card companies liked that setup.
If you, pre-Schumer Box, tried to find out what a card would cost
you before you applied, you would have discovered that you probably
could not, even by calling the card company. The people who
answered the phone did not have the answers to questions about the cost
of the company's card. Or if they did, they had been told not to answer those sorts of questions.
Even with the Schumer Box, card companies are still looking for,
and finding, ways to avoid disclosing the costs of cards, even the costs
that are in the box. For example, many solicitations for pre-approved
cards prominently tout their "low, low" introductory interest rates of,
say, 5.9 percent. But many of those solicitations do not fully disclose
when that introductory rate ends or what the new, higher rate will be.
A low introductory come-on rate that lasts only a couple of months
before going up to a super-high 19 or 21 percent annual interest rate is no bargain.
What does it cost you to have a credit card? Probably more than
you think. The five main things that determine your costs are:
- Annual fee
- Interest charges on purchases
- Grace period
- Cash advance fees, late fees, over limit fees, etc., and interest charges
- The way the interest charges on purchases are figured
- Annual fees
- The annual fee is the first and clearest cost of having a credit card. The
services offered by cards that charge the highest annual fees are mostly
the same as those provided by the less costly or no-annual-fee cards.
All of them let you charge your purchases at hundreds of thousands,
even millions, of places around the United States and the world.
And sometimes the more expensive cards do not offer services that
measure up to the cheaper ones. For example, American Express and
Diners Club cards are accepted by many fewer stores and restaurants
than Visa and MasterCard are. This is true both in the United States and abroad.
It stands to reason, since it costs the store less to take the bank cards than
it does to take the Amex or Diners card. Thus, less pricey places can absorb the
cost of the bank cards while only the more expensive places can pay what Amex
and Diners charge.
- Interest rates
- Many people don't know that interest rates are different from one card
issuer to the next or think the differences are not large. But they are
large-in fact, very large at times. Some rates are relatively low, other rates are absurdly high.
That is not the only interest rate difference between card issuers.
There is also a big difference in the way they figure interest rates. Some
credit card companies offer rates and ways of figuring rates that are
not too bad for you. Others have very clever ways of ripping off their customers.
If you know what to look for you will save yourself lots of bucks. If
you don't know what to look for, your bank account will suffer. And
some credit card company will be very happy.
It's no accident that credit card interest rates can be hard to
understand. Interest rates can be figured in a variety of simple and
not-so-simple ways. Banks have spent a long time developing the not-so-simple
ways, and working to make them more and more confusing. Bankers
do this to hoodwink customers, keep profits high, and keep customers
confused. People who do not understand what is going on are easier to rip off.
Indeed, the banks have made computation of credit card interest so
complex that even many bank employees do not understand how it's
done. This is especially true of the kindly folks who attempt to answer
your calls at the credit card service center.
The banks like it that way. They use at least six different methods of
charging you interest. All credit card companies could use the same
method of figuring interest to make it easy for you to compare costs
from one card to the next. There is no reason that the Congress or the
Federal Reserve Board could not take one understandable method and require all card companies to use it.
But consumer confusion means profit for the card companies. And
the card companies have a lot of clout with the Fed and the Congress.
The Federal Reserve Board ought to do something, but it hasn't gotten around to it yet.
And now credit card companies use computers to make figuring out
interest rates even more confusing. Before computers, interest rates
had to be somewhat easy to work out. Otherwise, the companies'
employees could not do all the calculations needed to compute the
interest on accounts. Now computers figure the interest on your account in
a microsecond using methods that would take a clerk days or months
to figure out with an adding machine.
Federal law requires that each and every bill you get from a card
issuer have the interest rate clearly written on the front. Two interest
rates, in fact: the annual percentage rate, which is the yearly rate, and
the periodic rate. The periodic rate is the monthly rate, since you
usually get billed once a month. The two rates are really exactly the same
rate, but figured over different time periods.
- Grace periods
- The grace period is the time after you buy something during which you
can pay the bill and not have to pay any interest. Traditionally, you
had twenty-five or thirty days from the day your bill was sent to you to
pay it in full without any interest charges being added on to the
amount due. The grace period is a tradition, not a law.
This tradition comes from the way merchants ran (and some still
run) their store charge operations. Long before there were plastic
credit cards, many stores let their customers put their purchases "on
the account." And they allowed the customer a month or so after billing to pay up.
When credit cards first appeared, the credit card companies
followed the same policy. They had to in order to compete with the store
accounts. Now that card companies dominate the financial
marketplace, they would very much like to finish off the grace period, or as
they call it among themselves, the free-ride period. They would like
you to pay interest from the day you buy something until the day you pay it off in full.
Some banks have actually had the nerve to put this immediate
interest plan into effect, often camouflaged with advertising claims of
"lower interest rates" or "a lower annual fee." The disguise is needed
to keep outraged customers from looking for a new card company.
Fortunately, so far, the grace period has managed to survive in the
banking world. Killing off the grace period would be a very bad deal
for you, the consumer. Banks started out promoting their credit cards
as cost-free to you if you paid the bill within the grace period. That was
to bring in the customers. Then they thought up annual fees and all
kinds of other fees. Now they want to get rid of the grace period so
that you will always be paying interest.
Many banks (and merchants, too) have a policy that keeps the grace period, but
eliminates it completely if you do not pay the balance due on your account in
full before the end of the grace period. That is, if you do not payoff your
balance in full each and every month you will pay interest on everything you
buy. That includes even the things you payoff in full within the month after you
get billed for them.
If you do not pay all of the previous month's balance on your card
account, you will probably be charged interest on everything you
charged in the previous month and in the current month, too. Not
paying your card bill in full every month is a very expensive way to go.
This billing method of the card companies is not a reasonable or fair
policy. But almost all now do this. So you are stuck with this chopped-
off grace period if you use a bank or store credit card.
Soon the credit card companies will have you paying interest on things before
you buy them.
Travel and entertainment cards usually have the same grace period
of twenty-five or thirty days, but, in theory at least, you must pay up
within the grace period or lose your card. In fact, it is usually possible
to stretch the period a bit since often the T&E companies will not
charge interest or a late charge unless you run considerably over thirty
days past due. But if you run over too often, they will eventually get
upset, you could get charged fees, and your account could be closed.
- Cash advances
- What is a cash advance? The banks promote it as a trouble-free
way you can get cash anywhere in the world. Normally, it is
trouble-free (but not cost-free), at least in the United States.
Outside the United States it is a different story. Many card
companies are desperately striving to find ways to make money off foreign charges. And they are succeeding.
Getting a cash advance is not like charging cash, as many people
think. It is like getting a loan. That is why American Express and the
other travel and entertainment cards issued by companies that are not banks can't give you a cash advance.
What is the difference between charging cash and getting a loan? If
you were charging cash when you got a cash advance, you would
normally have a grace period of twenty-five days or so after you got your
bill. Within that period you could payoff the charge without it costing you any interest.
A cash advance works in a different way: you get no grace period.
There is generally no way to avoid paying interest when you take out
a cash advance. The cost of cash advances is difficult to understand.
First, the way the banks figure cash advance interest is very
complicated. Second, once upon a time, in the early days of bank credit cards
(around 1972), you could actually get a no-interest, no-fee, free-ride
cash advance with some bank cards. Those cards gave you a grace
period before interest was due on cash advances. This has not been true
for a long time, but the memory of those happy days lingers on and
confuses many folks' view of the current situation.
It is also possible for a cash advance to cost you interest on all the
things you charge, even if they would normally be interest free. How?
Because some especially greedy banks eliminate the no-interest grace
period when you have a cash advance outstanding on your account. If
you have many purchases on your account this can be very costly.
So you have your not-so-trusty, bank-issued credit card in hand.
You go into a bank (not the one that issued the card you are using) and
say to the teller, "I'd like a hundred-dollar cash advance on this card."
What happens, and what is it going to cost you?
First of all, the bank where you get the money should not (in fact,
by their contract with Visa or MasterCard, is not permitted to) charge
you anything for giving you the cash. If you ask for a cash advance of
a hundred bucks, that is exactly what you should get. The bank that
gives you the cash gets their cut from the bank that issued your card.
The bank that issued the card, however, with a few exceptions, will
not do anything for you at no charge, cash-advance-wise. It will almost
certainly charge you interest at a high rate from the day the charge for
the advance is sent to the bank card clearinghouse by the bank that gave you the cash.
Many card-issuing banks have worked up their nerve to charge a cash advance fee.
This is rather like your local department store charging you a
"merchandise purchase fee" in addition to the price of your new socks.
Ridiculous as it is, many banks do this. Some charge fees as high as 4
or even 5 percent of the amount you get in the cash advance. When
added to the 18 or 20 percent interest you are also charged, this can
give the bank an effective annual interest rate of 100 percent or even
more! Not bad for the bank. But terrible for you.
Even if you find a bank that charges no cash advance fee, getting
cash advances for anything other than emergencies (or when abroad;
cash advances overseas can make sense as a way of cutting foreign
exchange commissions and costs) is not a super idea because, even
without the cash advance fee, you still will be charged interest on the cash
advance from the day you take it out. Remember, there is no grace
period on cash advances, even with a card that has a grace period on regular purchases.
Why pay very high interest charges just to get some cash in your
hand? Write a check on your bank account or make a savings account
withdrawal. Reserve cash advances for travel and for emergencies and
save yourself money.
- How to get your best credit card deal
- In shopping for the best deal from a bank in your area, the best you
may be able to do for local pricing is call around to several banks,
savings and loan associations, and credit unions. Ask them what their
interest charges are. While you are on the phone be sure to also ask what
their annual fees, grace periods, and charges on cash advances are.
When you are calling be sure to ask the person with whom you talk
if he or she knows of any banks in the area with no annual fees or with
very low interest rates. Sometimes the bank folks you talk with know
the charges at banks allover town. Often they will be glad to tell you
about a local competing bank that issues no-fee cards.
- From Your Wallet to the Bank's Vault
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