“Buy now, pay later” is the modern way of life. Credit cards are a highly profitable business for the companies that issue them, so it’s no surprise that banks continue to inundate consumers with credit card offers, especially during the shopping frenzy of the holiday season. These come-ons are among several financial traps lurking out there today.
Visa (V), MasterCard (MA), Discover Financial Services (DFS) and American Express (AXP): Their cards are common fixtures in hundreds of millions of wallets around the world. According to Federal Reserve data, the average credit card debt per card-holding U.S. household is $16,140. In total, the average American consumer owes $918.5 billion in credit card debt.
You probably get credit card offers in the mail all the time; the volume of unsolicited offers tends to increase the day after Thanksgiving. Here’s some important information that will help you sort through the pitches and separate the good values from the rip-offs.
The Introductory Rate
The introductory rate, or “teaser rate,” expires after a designated period of time. Federal law requires introductory rates to remain in effect at least six months after signup. This rate is below market and typically applies only to balance transfers and cash advances, although they can also apply to purchases. Introductory rates are usually extremely low, ranging from zero to 4 percent for up to 12 months. Be sure to read the fine print for what the percentage rate will be once the initial introductory period ends.
Annual Percentage Rate — Fixed vs. Variable
If you don’t pay your balance in full by the due date, you’ll be charged interest on the remaining balance. How much interest you pay is determined by the annual percentage rate, or APR, on the card.
If you pay the full balance on your credit card every month, you won’t have to pay any interest on your balance ($0), and can ignore APRs.
All credit cards have either a fixed or variable APR, determined largely by the “prime rate,” which is the interest rate commercial banks charge their most creditworthy customers, which are usually corporations. For example, if a bank is offering a credit card at “prime plus 5” and its prime rate is 6 percent, then the bank is essentially offering customers an 11 percent loan (6 percent + 5 percent).
A fixed APR locks in your rate so that it does not fluctuate with changes to the prime rate on which it is pegged. The variable APR, on the other hand, moves in step with the prime rate. If conditions are volatile and interest rates spike, the variable APR that originally enticed you can end up bearing little resemblance to what you actually pay.
While it’s preferable to have a card with a fixed APR, these cards are few and far between. As of this writing, the average fixed APR is at 13.1 percent and the average variable APR rate stood at 15.7 percent.
Cards for Bad Credit
Everyone deserves a second chance. At least that’s the premise behind credit cards for those with bad credit. In most cases, these types of credit cards are “secured,” which means that the person must put money onto the card upfront before he or she can access the credit via the card.
Some companies offer “unsecured” credit cards with low credit limits and high interest rates. These rates can reach up to 20 percent or higher.
The rationale for secured and unsecured cards is that, in today’s society, a credit card confers legitimacy on people and makes life easier. It’s becoming harder and harder to function by simply using cash. Also, if you have bad credit but you rack up a good history with these types of cards, you can repair your damaged credit score.
Some credit cards are tied to charges for hotels, rental cars, air travel, grocery and gas purchases, etc. The premise is that the more products and services you purchase, the more “points” you earn in return for free or discounted rewards.
But beware: Many of these incentive-based cards come with high interest rates and big annual fees. That said, if their interest rates aren’t excessive and there aren’t a lot of hidden restrictions or fees, reward cards can be a good deal, offering free hotel rooms, bonus rental car use, free airline tickets — you name it.
Nonetheless, cast a discerning eye on the agreement. For most frequent flyer credit cards, you’ll see high interest rates and restrictions for the privilege of getting miles in return. It’s not worth it and tantamount to paying for overvalued stocks.
Evaluating the Key Areas
Now that you’ve been tutored on the basics, here are the most important areas to scrutinize when weighing the pros and cons of a credit card offer:
What’s the interest rate? Compare fixed and variable APRs. If you think interest rates will remain stable, you might want to opt for the lower variable rate. Remember, that’s a risky option. If interest rates go up, you lose.
Thanks to the new credit card laws, the companies that issue cards can’t raise rates on existing balances during the first year unless a prior promotional rate expired, the index on a variable index rate increased, or you were 60 days late in paying your bill. If your rate rises because of a late payment, the bank is required to restore it to its lower rate once you’ve made six consecutive monthly payments, on time of course.
Is there an introductory rate? If so, what is it and how long does it last? If the introductory rate is more than 13.1 percent (the average fixed APR) and doesn’t last at least six months, forget it.
Is there an annual fee? A credit card annual fee is a yearly fee — typically ranging from $15 to $300 — charged by the credit card company for the privilege of letting you have the card. Don’t agree to pay much more than about $50. If you can, opt for a card with no annual fee.
What’s the late fee? If you make a late payment, what will you get charged? A typical credit card late fee is about $35.
What’s the over-the-limit fee? Look for cards that don’t impose a charge of this kind. Some cards will notify you if you’ve gone over your limit without hitting your pocketbook with a penalty.
Are there any hidden fees? Some cards charge balance transfer and account termination fees. Avoid these cards. You can find cards that don’t incur such fees.
Also beware of fishy interest calculations. There are many ways a card issuer can calculate interest owed. One of the shadiest tricks is to use a late payment as a reason to jettison the interest-free period for new purchase transactions and then calculate the interest as far back as the original purchase date.
Another dodgy maneuver is to charge daily interest on the full purchase amount even if partially repaid on deadline. Read the fine print on your credit card statement. If the contract allows the card company to get away with either of these schemes, cancel your card and look for one that only charges interest from the date the new statement was produced.