The Truth About Credit Cards 

Introduction 

Credit card companies are aggressively pursuing college students.  Under regular credit criteria many students would be denied a card because they have no credit history and little or no income.  Sallie Mae, the student loan agency, found that more than 75% of college students have credit cards.  Half of all college students with credit cards don’t pay their balances in full every month.  Credit card companies encourage consumers to make low monthly payments so the companies can make money in the form of interest.  Before you sign an application for a card, take a hard look. 

Often a student is given a credit limit of $1,000.  The credit limit you are given does not necessarily reflect the balance you can afford to carry.  For example, if you charge $1,000.00 at 18% APR, it takes 12 years at the minimum payment to pay it off.  You will pay $1,115.00 in interest alone over that period.  Check out the online credit card calculator to calculate how much it will cost you to pay off your charges at the monthly amount you choose.

Navigating Credit Card Offers 

Shop around for a credit card that best fits your needs.  You can get a free list of low rate credit cards online at www.bankrate.com.  When comparing the different offers, you will need to understand the following keys terms of the contract.  Terms and conditions vary widely so it’s important to compare all the terms of the offer.  Key terms you should know:

  1. Annual Percentage Rate (APR) - The amount of interest assessed on an outstanding credit card balance.  For billing purposes, the APR is usually divided into periodic (monthly or daily) rates.  A variable APR, often referred to as “prime + x%,” is tied to an economic market index such as the Prime Rate; thus it fluctuates with the economy.  A fixed APR does not fluctuate with the market.  Rather, it is set by the credit card company.  Be aware that the company can change the rate on both variable and fixed cards with as little as 15 days notice to cardholders.  APR can range from 7.99% to 30.25%.
  2. Penalty APR - A much higher, punitive interest rate that credit card companies may apply to cardholders who have exceeded their credit limits, made one or more late payments, or are otherwise in “bad standing.”  Penalty APRs are, on average, about 52% higher than regular APRs.  Look for a card without penalty APRs.
  3. Grace period – The time during which a transaction does not accrue interest.  Grace periods range from 0-30 days, with an average of 23 days, and they often apply only to purchases, not cash advances or other transactions.  Look for at a least 25 day grace period.
  4. Transaction fee – Cardholders are nearly always assessed additional fees for transactions other than purchases (such as cash advances).  The fee is usually a percentage of the transaction, but a minimum fee may apply.  Transaction fees may or may not be capped (have a maximum fee chargeable for a single transaction).
  5. Cash Advance – An immediate cash loan from a consumer’s credit card account.  Cash advances may carry a higher APR than purchases, and often are assessed transaction fees.  Grace periods may not apply to cash advances.
  6. Credit Limit – The maximum balance that can be maintained on a card at any given time.
  7. Minimum Payment – The amount of money that must be paid on the account, usually on a monthly basis, to avoid late fees and to maintain compliance with the credit contract.
  8. Methods of Computing Balances

    Average Daily Balance - The outstanding balances for each day in the billing cycle are added, and this total is divided by the number of days in the billing cycle.  New purchases may or may not be added, depending on the terms of the card.  If the terms state that new purchases are included, purchases made during the billing cycle will raise a cardholder’s balance and may increase the finance charge.  Once the average daily balance is calculated, interest is assessed each day at the daily rate, which is the annual percentage rate divided by 365.

    Adjusted Balance - Payments or credits that are received during the current billing are subtracted from the balance at the beginning of the billing cycle.  New purchases are not included in the calculations.  For example, if a cardholder’s beginning balance was $2,000, and s/he made a payment of $500 during the billing period, s/he would only be charged interest on the remaining $1,500.  This is generally the most consumer-friendly computation method.

    Two-Cycle Balance - Credit card companies add together the average daily balances for the current and the previous billing cycles.  The average daily balance for the current billing period may or may not include new purchases.  The two-cycled balance method is the least consumer-friendly method of balance computation.

    Secured Credit Card  – This type of credit card is linked to a bank account, allowing a credit card company to deduct payment if the cardholder fails to pay. 

Credit Card Traps

  1. Hidden Transaction Fees - Often buried in the fine print, these fees apply to cash advances and balance transfers.  For example, if the card has a transaction fee of 3% and a minimum of $10, a cardholder who receives a $50 cash advance will be charged a minimum $10 which amounts to an actual transaction fee of 20%.
  2. Late Fees - The fee assessed when you don’t pay on the due date- the average rate fee in 1992 was $27.61.  Look for a card with a fee no higher than $20.
  3. High Over The Limit Fees – Fees can range from less than $20 to $35.  Many companies assess the fee when you exceed their limits by as little as $1.
  4. Annual Percentage Increase – Penalty APR are triggered by a late or missed payment.  They are now on average nearly 8 percentage points higher than the average regular APR.
  5. Short Grace Periods – The time period during which a transaction does not accrue interest.  Historically, they were 30 days. Now they average about 23 days.  Some cards have no grace period at all.
  6. Low Introductory Rates – Generally, introductory rates turn into very high regular rates.   The rate increases are not prominently disclosed.  Read the fine print.
  7. Bait and Switch Credit Card Offers – The offer advertises the premium card but the fine print allows the company to substitute a non-premium card with a higher APR and fees, if the applicant doesn’t qualify for the premium card.

Use Your Credit Card Wisely

  1. Know Your Financial Limitations – Don’t spend beyond your means.  Create a budget that takes into account your average credit card payments each month and stick to it.
  2. Pay off Your Entire Bill Each Month – By far, the best option is to buy only when you can pay your bill in full, before you decide to pay over time.  Use the credit card calculator available on line at Debt Pay Off Calculator to calculate how much you will need to pay each month to pay your balance within the time you have specified.  You can calculate how long it will take you to pay off your balance at the monthly payment you propose.
  3. Reduce Credit Card Fees – Getting rid of all but one or two cards means you avoid fixed costs, such as annual fees, and makes you less vulnerable to incurring multiple late payments and incurring over the credit limit fees.
  4. Be Prepared to Switch Cards - If you are unable to pay off a large balance, pay as much as you can and switch to a credit card with a lower annual percentage rate (APR).  You can obtain listings of low rate credit cards through www.bankrate.com at no cost.

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