4/21/2014 2:45 PM ET|
10 dirty secrets of the credit card industry
The less you know about the plastic in your wallet, the more it could cost you.
Credit cards may appear to be convenient plastic rectangles in your wallet, but they can be something more sinister: sneaky debt traps.
The booby traps you encounter may not be your fault but rather those of an industry that values profits and thrives off of your mistakes.
But no need to read the fine print on your credit card terms or do the heavy lifting: below are some secrets about credit cards that are buried in all those numbers and regulations you don't get paid enough to research.
1. Paying minimum payments drags balances out
The minimum payment on your bills isn't a dare; it's what's been mathematically calculated to drag your payment out so long that you pay at least double what you actually owe. This isn't just credit cards; it applies to every consumer loan in the world. The only difference between banks and loan sharks is the amount of time you're given before the compound interest on your loan compels them to come pounding on your door.
"The higher your interest rate, the more your payment goes toward interest, rather than toward principal, and the longer it takes to get out of debt,'" says Gerri Detweiler, director of consumer education at Credit.com, an independent website that helps consumers make smarter credit decisions.
Credit.com includes a free credit card payoff calculator (which you can access here) that allows you to input your credit card's balance, interest rate and minimum payments to see the sobering truth about how long it'll take to pay off your balance, along with how much interest you'll pay by the end.
And remember, we're discussing only on your credit card debt (which is only a small portion of your overall debt). Let's not forget the 2014 Student Loan Outlook...also how New Mortgage Rules Go Back to the Future.
2. Late payments aren't regulated very well
The laws about late payments are sketchy at best. They're capped at $25 for your first infraction, but the government only protects you from the banks until you really start getting into financial troubles.
If you're habitually late, not only will you be paying the banks all that interest above, but you'll also be paying higher and higher late fees. We saw this in the mortgage industry as well, when struggling borrowers were hit with exorbitant force-placed insurance fees, pushing them over the foreclosure cliff. We live in a capitalistic society, and if you don't pay your bills, Uncle Sam will turn his back on you.
"Timely payments establish a track record of reliability and boost credit," says Randy Hopper, AVP of credit card lending at Navy Federal Credit Union. "If possible, set up automatic monthly payments along with text and email alerts to remind you of your due date."
3. Interest rates aren't capped
There are a lot of laws regarding credit card interest rates, but they have more to do with the way banks were selling the cards to you. What they do is give you a low introductory rate, then hike the interest rate up as high and as often as they can. The CARD Act President Barack Obama signed in 2009 somewhat limits this deceptive marketing technique, but where there's money to be made, banks will find a way.
"If you have a variable interest rate, call your credit card company and ask that the rate be capped or ask to switch to a fixed interest rate," says Harrine Freeman, author of How to Get Out of Debt: Get an "A" Credit Rating for Free (Adept, 2006). You can pester the credit card company enough to lower your rate if you're vigilant, but normally the powers that be just keep upping your available credit while slowly creeping that rate up on you and extending the term limits.
If you're confounded and interested in compound interest, then check out what BankingMyWay taught MainStreet on the subject in How to Avoid the Credit Card Interest Trap.
4. Making 2 payments per month lowers interest
Interest is compounded in various ways, but you're not interested in any of them. The very least you need to know about credit card interest is it is a revolving line of credit. There's no penalty for paying credit cards off early (although there are subtle penalties for paying them in full every month).
Making two payments each month to your credit card drastically reduces the interest you'll pay on it. Even if you can't make two full payments, splitting your normal monthly payment in half and paying it in two installments makes a bigger difference in the long run than you think. It's like a butterfly flapping its wings in your present to create a tsunami of cash flow in your future.
5. Any late payment raises rates across the board
Real life is exactly like high school, and your credit report is your permanent record; keep that in mind when debt collectors call you. In the school of life, your financial administration tracks tardies. You'll get perfect attendance awards so long as you show up on time. If you're tardy in one class, your teachers start talking, and you're labeled as a problem child. Keep in mind, though, not everyone reports to the credit bureaus; the only way you'll know is by requesting a copy of your permanent records.
6. Cash advances are paid off last
If you need money to pay off a bill that doesn't accept credit, you're better off maxing out your credit card buying things you can turn around and sell than you are pulling cash out of your credit card. The banks rearrange balances so the highest interest balances are paid off last. Take a look at your subsidized and unsubsidized student loan balances if you want to see this ridiculousness in action.
Your credit card may have a 2% rate, but the interest rate on cash advances (the highest interest rate transaction) is at least triple that. This means the only way you'll ever stop paying that high interest rate is by paying off your entire credit card balance, which brings us to the next topic.
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7. Paying your full balance every month hurts your credit
Banks are in the business of making money; it's the product and byproduct of their business. They're not your buddy, and, although they're very much a part of your family, you're not a part of theirs. Have you ever seen a bank on the show "How Does It Work?" Does your account come with "Behind the Scenes" footage of what your bank does behind the scenes?
"Using a credit card is not a bad thing, but it is important to remember that credit cards are not 'free money,'" cautions Elle Kaplan, CEO of Lexion Capital Management. In fact, they are very expensive money." That being said, when you pay off your full balance every month, the banks don't make any money off you, and you've effectively stunted the growth of your credit rating.
The credit report algorithms are a pain. There's a minimal positive point impact going from $1000 available credit with a $0 balance to $999 available credit with a $1 balance, but it gets really gray as to where the balance is between the slight credit push and throwing money away on interest. In the long run, your credit report score will help you more than liquid assets.
8. The difference between credit and charge cards
There are exceptions to every rule, and in the credit card industry, most of those exceptions are attributed to the fact that you have a charge card, not a credit card. The most famous charge card is the American Express card, although Amex issues credit cards as well (branded Optima and Blue).
With charge cards, you're charged a fee for using them, and you're billed by an entirely separate set of rules and regulations. They also affect your credit report in different ways, as charge cards don't necessarily have a firm limit (despite what they tell you), so your available credit ratio is negatively offset. Pre-paid cards work similar to these (as do those oh-so-cleverly marketed Visa/MasterCard/Amex "Gift Cards").
9. Store credit cards are like Disney cash
Store credit cards (which is to say a credit card that is only good within the store) don't show up on your credit report the same way. When you open a normal credit card with a $1,000 credit limit and you spend $500, you have $500 available credit to use. This gets reflected in your credit score, and your credit rating is raised because you have a recorded nest egg of available credit.
When you sign up for a Best Buy credit card with that same $1,000 credit limit, it doesn't matter how much you spend; it'll always look like $1,000 with $0 available credit. If you run out of money, you can't pay rent with a big screen TV, so you may want to melt it into a pole to dance on.
"Experts differ about the ideal ratio, but all agree that keeping your debt below 30 percent of your available credit line is key to ensuring your credit score isn't negatively impacted," offers NFCU's Hopper.
10. Assorted credit report and debt collection tips
There are both state and federal laws that protect you from being bullied by financial institutions, but they're more guidelines than an actual code. Some states also protect you better than others; Massachusetts and Maryland, for example, have such great consumer phone protection laws, and it's hard to believe our boys in the NSA dropped the ball on constituent privacy.
Debt collectors are limited in the number of actual contacts they make, so you're actually better off answering the phone than not, as they can call as often as they want, and leave way more messages than actual contact. They're also limited at the time of day they can call you. If you receive a call between 9 p.m. and 7 a.m., it's not your bill collectors...and if it is, you can file a complaint with the Consumer Financial Protection Bureau.
Financial institutions have a lot up their sleeves, but I've seen behind a lot of curtains. From debt collection to payoffs, the financial operations of every business are essentially the same. Whether you like it or not, Americans exist to make money (yay Capitalism!). If you want your piece of the pie, you need to understand how the system works.
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I’ve got to agree with J. C. on that number 7. I regularly pay off my credit card charges every month and my credit score remains stellar.
As for the other “secrets”, they’re not very secretive at all to anyone with two neurons to rub together. All in all, a pretty useless article.
What are the "subtle" penalties when you pay off your balance every month?
Have two cards
Pay off monthly
No late charges
Excellant credit rating
And they pay me..........No brainer folks.
Thank you so much for the statement about "The booby traps you encounter may not be your fault ......" That is probably the worst thing you can tell consumers. Because alot of it IS their fault. Probably 9 out of 10 problems are the fault of the consumer.
As someone who works in the customer service department of a credit card company, I get to see both sides of this proverbial coin. I too get disgusted by the ways credit card companies do business and think there are a lot of unfair things they do.
But I also am in the position to see how many problems consumers cause themselves either by carelessness or basic stupidity. The first thing consumers seem to forget is that that have a resposibility to be aware of their bills. I can't tell you how many times someone has told me they went on vacation and that's why they did not pay and have the nerve to act like it's the banks fault as well as curse at me for the horrible crime of asking how I could help today. The bank can send out bills and text reminders all day long, but ultimately it's up to that customer to make sure the bill is paid and paid for the right amount.
It's also amazing how many people will call questioning that charge on their bill that says 'Finance' or 'Interest' charge. Not how it's calculated mind you....what it IS. Credit 101 folks!! It's not free money. You don't pay off all the charges, the bank charges a fee for loaning it too you.
The two stupidest phrases I have ever heard when it came to someone not wanting to pay the late fee for failing to pay their bill. One woman told me "I lost the bill....it's not my fault." Really? Did you hear what you just said??? And a young consumer (yes, we at the bank can see your year of birth and know exactly how old you are), she was about 21, told me, "I am too busy to pay attention to my bills." I swear if banks could close accounts for sheer stupidity the rest of us consumers would be better off.
I really wish more writers would do articles about what consumers do to cause themselves problems rather than continually focusing on the "evil" banks. Talk to anyone who works a call center for a credit card and they will tell you stories that will make you laugh and then cringe at the ignorance and ridiculousness of people. And we can also tell you the best ways to get what you want when calling a credit card company about a problem. Number 1-don't be ugly to the person who answers your call. I am obligated to be nice to you, even when you yell at me and call me names, but I can also decide that any exceptions I have the ability to make won't be utilized. The flies with honey saying is very true.
Also, zero-balances only have a negative effect on your credit score if all of your accounts have a zero-balance. The best possible situation for your credit score is to have a zero-balance on every account but one, and a very small balance on the remaining account.
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