What started out with good intentions for the American consumer is now turning into its worse nightmare. Having the access to credit was supposed to be a luxury and not a necessary. Now, many Americans cannot function without the access to a credit card.
How do we break this cycle of reliance on credit cards?
What is our long term benefit of even having a credit card?
We know short term, we are able to buy that high ticket item now that we cannot afford with our small bank account.
We are able to go on a vacation and live well for a week and worry about the bill later on.
Credit cards are a billion dollar industry. Banks make a staggering amount of money on the interest that they charge and the late fees that they collect. Also, there are numerous small fees and charges that we are hit with every day without our knowledge.
The interest on that credit card was 18% annually. By the time you pay off the flat screen TV fifteen years later, you would have tripled the amount that you paid in 2004.
Interest, my friend, is one of the main sources in which the banks make their money off of you when you use your card.
Your monthly payment to the card company is made up of principal and interest. The principal is the amount that you borrowed, and the interest is the cost of borrowing the money for the purchase. Interest rates on cards can vary from as low as 4.99% to as high as 30%! The interest rate is dependent on the borrowers credit score. The higher the credit score, the lower the interest rate you would be charged.
So for example, if you have a credit score of 775, a credit card company may charge you 4.99% and give you a $10,000 limit. If you have a score of 557, they may charge you an interest of 24% and give you a $3,000 limit.
The credit card companies do this because they feel the individual with the lower credit score will be a higher risk to default on the credit card account. They will, in turn, give a lower credit limit and charge a higher interest rate. If the individual shows a positive payment history, the they will increase the credit limit and may reduce the interest rate.
Plenty of times they will increase the credit limit but will keep the same interest rate.
When you make your monthly payment, most of your money goes towards the interest and a little goes towards the principal. This is because your payments are amortized.
Amortization is when a part of the payment goes toward the interest cost and the remainder of the payment goes toward the principal amount, the amount borrowed. Interest is computed on the current amount owed and then will become progressively smaller as the ending balance of the loan reduces.
Because of the way amortization is set up, you can end up paying double to triple of the value of the original amount of the principal borrowed.
Amortization is just one of the ways credit card companies keep us trapped in financial debt for all of our adult lives. There are several credit card pitfalls that you need to be aware of.
Cash Advances – Every credit card allows you the ability to draw out cash either from the ATM machine or through convenience checks. These cash advances come with a heavy price. Cash advances are charged a much higher interest rate (from 20-25%) than a regular purchase. Even if you use a convenience check to transfer a balance from one card to another, you will be charged a higher interest rate. This is like legal loan sharking.
Credit card companies will send convenience checks in the mail with your bill every month to tempt you to use them. They will make it seem that it is just as easy as making a purchase with your credit card. The fine print will say otherwise.
Avoid using cash advances as much as possible. There is no grace period with cash advances unlike regular purchases where you will have a 30 day grace period to pay back the balance before the interest kicks in. The interest with cash advances kicks in the minute you draw the money out of the ATM machine.
Late Fees & Over the Limit Charges – Besides the exorbitant interest rates that the credit card companies charge, fees are the next biggest way that they make their money. The fine print gives the credit card companies’ free reign to change interest rates at whim whenever they want. A late payment or an over the limit charge will trigger these higher interest rates.
Most companies charge a $30 late fee if you pay after the five day grace period. If you have a low interest rate, this will give the credit card company the authority to charge you a higher interest rate from that point on. You interest rate can jump from 5% to 18%.
If you go over you credit limit, most companies will charge you a $35 over the limit fee and the difference that you are over. They will also start to charge you a higher interest rate because now you are “maxed out”.
With the current credit crisis, card companies are lowering limits without proper notice causing customers to charge over their limit or maxing out their account. Once again, the customer is hit with a higher interest rate by no fault of theirs.
Annual Fees – Some credit card companies do not charge an annual fee. The ones that do will charge $150. They may charge it all at once or break the fee up into 12 even payments.
If you do not pay the fee in full, you will be paying interest on that annual fee, plus also lose the credit availability. Check your monthly statement carefully. You may have a zero balance on your account. Once the annual fee is charged, now you have a balance to pay on. If you overlook when the annual fee is charged, you may run the chance of missing a payment and getting a derogatory on your credit report.
I have seen this happen several times. Whether you have a balance or not, check your statement carefully.
Small Miscellaneous Charges – Another reason to check your monthly statement closely is because there are small automatic fees that are charged to your account monthly that we don’t even notice.
I had a Chase Visa credit card that I rarely used. I kept a low balance on the card and the monthly bill was deducted automatically out of my bank statement. One month I looked through my statement, and I noticed that $15 per month was automatically charged to my account every month for the last four months!!!.
I called customer service and found out that I was being charged for credit card insurance in case I became disabled and couldn’t pay the bill anymore. Now I know we all may need this insurance, but I never authorized the charge. $15 per month is a small fee, but it adds up to $130 per month. If the credit card company gets 100,000 unsuspecting cardholders to overlook this charge every month, they will make $13,000,000 in profits. A small charge to thousands of customers can really add up.
Now that we know that it is in the best interest of the credit card companies to keep us trapped in debt, what can we do to keep ahead of the game?
The marketing efforts of credit card companies are getting more aggressive and creative. We are bombarded with ads everywhere we look. They are even targeting kids in high school. Teenagers are approaching their adult years already caught up in debt.
Here are some tips to apply:
Keep your balances low – As I stated before in this book, the lower you keep your balances, the higher your score will be. The credit reporting agencies will rate your score higher if you maintain your balance below 25% of your credit limit. Pay down your balance if you are over 50%.
Check your monthly statement closely to make sure your credit card company has not lowered your limit without your knowledge. Many times they will lower your limit first, and send out a letter later.
Because of the recent credit crisis, credit card companies are evaluating each account that has used over 50% of their limit. If they notice a drop in credit score, or even a late payment on another credit card, they have the right to lower your credit limit without notice. This is the “universal default clause” in the fine print of your account holder’s disclosure.
Use automatic payments – This is a great method to use if you are getting paid a set salary every pay period. By using automatic payments, you will be assured that your payments will be on time every month. You will not have to worry about late fees.
Some credit card companies delay applying your payment to your account if you are close to your grace period so they can make money on the late fee. We cannot control how quick our payment can get to the credit card company by snail mail.
Make sure you budget right so that you have enough in your bank account to cover the payment. You don’t want to pay both an over draft fee to your bank and a late payment fee to your credit card company. Now that’s a double whammy!
Charge what you can, then pay back in full – I have used this method for a very long time and this has worked out perfectly for me. For example, if I needed to buy a plane ticket for a business trip, I will charge the plane ticket for $199. Since it is a business trip and I am about to make money, I will pay the $199 charge in full at the end of the month when I get the bill.
I will avoid paying interest on that charge and this will also look good to the credit card company because I am paying more than the minimum monthly bill.
When you show a long history of paying more than the minimum monthly bill, you have a great chance of the credit card company increasing your limit.
By paying back immediately what you charged, you will not accumulate a balance that you have to pay back in the long term. This will save you hundreds of dollars in not having to pay interest charges.
If you cannot afford to pay cash for the item or able to pay it off at the end of the month, don’t get it!!
Negotiate your interest rate down – Once you have established a long term history of on time payments to your credit card company, you can negotiate with them to lower your interest rate; even if you don’t have a perfect score.
The credit card company does not want to lose you as a customer. Once you have established a good relationship with that company, it is your right to ask them for a lower rate. You have nothing to lose.
If they give you a lower rate, you save yourself hundreds of dollars. If they do not give you a lower rate, you can transfer your balance to another credit card with a lower rate, close the account, or do not charge anymore items on that account.
Try to use your credit card for emergencies & business expenses – We all know by now that having access to credit cards is a way of life in our society. We need it to build our credit scores. Credit cards are convenient to use when you have to make purchases online.
We have explored the evils and temptations that come with having access to credit cards, but when is the best way to use it to our advantage?
Instead of using credit cards to buy depreciating goods, to impulse shop, or to buy big ticket items, I feel there are two good instances to use your credit cards.
1. I have heard many financial experts like Suze Orman say to take your credit card and put it in the freezer. This will stop you from impulse shopping. She is right. Use your credit card for unexpected events like:
– Making travel arrangements to see a sick relative or to attend a funeral.
-Making repairs to your car if it unexpectedly breaks down.
-Making repairs to your home if your boiler burst or your roof leaks.
-Taking care of a small medical bill or to get medicine for yourself or your family.
These are some the legitimate excuses to use your credit card in case of an emergency. Things happen beyond our control. It is good to have the piece of mind to know that you can have your credit to fall back on in your time of need.
Try to pay as much as you can when the bill comes at the end of the month. You do not want to max out your limit. You have to replenish your credit limit in case another emergency is to arrive.
2. It takes money to make more money. There will be occasions where you will need a credit card to help finance some aspects of your business. Whether you have a startup or a seasoned business, you may need access to working capital to purchase products for your business. You may need to market and promote your business as well.
Instead of using your credit card to buy a product that is making that company richer, you are investing in enriching yourself.