The credit card industry is a complex and potentially dangerous one if you don’t know what you’re doing with your credit. PBS’ Frontline recently profiled credit card companies for a documentary that found, in part, that credit is often a damned-if-you-do, damned-if-you-don’t situation for many Americans. You need a credit card to establish credit history and secure better interest rates and loan opportunities, but getting a card often means dealing with spiraling payments and a temptation to live outside your means. It’s a tightrope that takes skill and concentration to walk with success. Yet for all the potential pitfalls involved with getting a credit card or working to build your personal credit, there are also major benefits, as well as tips and tricks that will help you manage your finances as well as warnings to help you stay out of real trouble. Credit card companies don’t necessarily hide these things, but they’re also in no rush to publicize them and affect their business. It’s up to the consumer to stay informed.
For starters, there’s almost no limit on late fees. In 1996, the Supreme Court ruled in Smiley v. Citibank that credit card late fees are classified as interest and therefore can’t be limited by the states when those fees are being issued by nationally chartered institutions. What does that mean in plain English? That credit card companies can assess whatever penalty they deem fit if your bill is paid after its due date, and there’s nothing anyone can do to stop them. As a result of the case, fees that had previously been $10 or less jumped to as high as $39, with many analysts predicting they’ll go even higher.
Another obvious lesson but one that lenders are often reluctant to discuss is that making only the minimum required payment on your credit card balance will lead to years of additional debt and wildly inflated prices on purchases. Here’s a graphic that breaks down a handy sample. Imagine buying a computer for $1,500 and charging it to a credit card that carries an 18% interest rate. Your minimum monthly payment is just a fraction of what’s owed, in this case 4%, and after each small payment the amount owed is recalculated and your payment period is lengthened. Paying just the minimum, it’ll take you 87 months — more than 7 years — to have paid off that debt, and in the end you’ll have paid $2,274 for a $1,500 item. However, if you pay $100 a month, every month, you’ll have the debt eliminated in 18 months and only have paid $1,712 in total. You can be a slave to the lending agency for seven years and pay a 50% markup, or you can knock the debt out in a year and a half and pay only a 14% premium. It took a federal statute, 2009’s Credit Card Accountability Responsibility and Disclosure Act, to make lenders clearly explain to consumers the cost of only paying the minimum required amount. Statements now have to include timelines that tell users how long it would take them to eliminate their bills if they only paid the minimum amount. It’s vital that you monitor this information.
Everything Is Negotiable
Credit card companies are a business, which means they have to balance their own financial interests with your happiness to keep you as a customer. Lenders don’t want you to pay off your balance. They’d rather you always have some amount of revolving debt. Because of that, they’re usually far more willing to work with you on things like interest rates and due dates than you might imagine. There’s no guarantee they’ll meet your request, and it might take a few tries to get them to play ball. But a little effort on your part will save you hundreds, if not thousands, in fees and charges. Interest rates fluctuate with time. Based on your financial status and payment history, it’s possible you could qualify for a better interest rate than the one currently attached to your card, but the lending institution isn’t exactly going to go out of its way to tell you that. (They’re not dumb.) In order to take advantage of better rates, it’s up to you to call and talk to the bank. This is also a chance to plead your case to another human being, which always yields better results than applying for breaks online. A 2002 survey found that more than half of those respondents who requested lower rates actually got them. To be sure, the economy’s in different shape than it was a year ago, but the rules and principles are the same.
You’re in Control
No matter how much you owe, you can make payments at any time. It’s true. Most people with credit card debt make payments on their monthly due date, whether they’re paying the minimum required amount or a larger sum designed to whittle down the total due. But you can actually make payments at any time, not just on the bill’s due date. And what’s more, doing so will help you eliminate your debt faster.
The reason this works is because the finance charges are determined by a calculation of your average daily balance, which is just what it sounds like: a breakdown of how much debt you had on the card during the month in question. If you had the same amount over a 30-day period, like $500, then your average daily balance would be $500. But if you had $500 on the card for 15 days and then nothing for the other 15, then your average daily balance would only be $250. It’s that average daily balance that combines with your interest rate to determine your relevant finance charges and what your bill will be. Therefore, it’s in your best interest to make that average balance as low as possible before the bill is tabulated. Make regular payments of any size to shave down the amount you owe, which will in turn reduce your average balance, finance charges, total due, minimum due, and the amount of time it’ll take you to wipe out that debt. It’s that easy.
You should also know that it takes a lot more effort to exercise control over credit cards than most people seem willing to exercise. People who buy on credit instead of paying cash spend more than they would have if they’d just used their own money. Some people’s purchase amounts jumped by 20% just because they were using credit cards and able to trick themselves into thinking they had more money or would be able to afford more lavish purchases. That mindset is a boon for credit card companies, but it’s deadly to consumers. People with credit cards think that luxury items are more attainable or worthwhile, when they’re not: Thanks to interest rates, those items are even more expensive when you buy them on credit. So you spend more in general, then spend again on top of that. Lenders might not like it, but you have to remember that you’re in control, and you don’t have to buy anything with your card that you don’t want to.
Another way to flex your muscle is to change your due date. This is one that most banks will work with you on, especially because you’re not asking to adjust the amount due, just when it’s submitted. Most people make this call in order to make their payment plan line up more easily with their employer’s payroll schedule. For instance, if you get paid on the 1st and 15th of the month, but your credit card bill is due on the 10th, it might be worth asking the bank to push that due date back a week if you want to apply funds from a different pay period toward your bill. It all goes back to demonstrating what kind of customer you can be, and what you’re willing to do to honor your debts. Many banks have little trouble with this change.
Further, it’s in your best interest to keep the balance on your cards as low as possible. Banks like to entice potential clients with high credit limits, offering $6,000 or $10,000 just for looking like a good spender. But they also know that this inflated limit will trigger a consumer’s habit to spend more with credit than they would with cash, and to spend even more than usual because the idea of a high credit limit makes the card sound safe and impossible to abuse when it’s actually a trap for gullible consumers.
The House Always Wins
The biggest mistake people make in thinking about credit cards is forgetting where the money comes from. You’re not actually borrowing from a lender. You’re borrowing from yourself based on the money you imagine you’ll have in the future, and the lender is placing a wager on your ability to actually come up with money owed. In other words, you’re never actually taking into account how much things cost, only how much you can reasonably part with at the moment. This, it should go without saying, is wildly dangerous and the first step on the path to bankruptcy. (Spoiler alert: even employed college grads go bankrupt thanks, in part, to credit cards.) Lending agencies don’t want you thinking like this because living within your means will mean putting small or vital items on a credit card and then paying off the balance in full before the month is out. That’s great for you because it builds your credit and proves that you’re responsible, but it’s bad for the banks because it shows that you’re not dependent on their credit cards to survive. Remember: Cards are just a tool. They have to be used correctly to work.
Article and research performed by the BusinessInsurance.org team.