Credit Cards and Interest Rates

Although there are some people who manage to live without having credit card, most people need one.  (For example – when you start a job, you usually have to wait at least two weeks, before you get a paycheck.  Having a credit card makes it possible to buy what you need, while you are waiting for the cash to come in)  There are many other benefits to having a credit card:

  • It helps create a receipt for everything that you buy;
  • It can protect you, if there is a dispute, and the store will not help you;
  • It can help you build (or establish) your credit score, by having the card and maintaining a history of on-time payments;
  • It can make it possible to get a hotel room, rental car or other items where the seller will not deal with you, unless you pay in cash or can give them a credit card number.

But, BE CAREFUL, just getting a credit card does not mean that you can stop caring about the details.  There are several things to keep your eye on – such as:

  • Whether your card is a department store card, or a ‘third-party’ credit card;
  • When the minimum payment is due; and
  • What the interest rate is.

If you aren’t careful with your credit card decisions, you can find yourself in a heap of trouble. Keep reading to find out what questions you need to ask and how they should be answered. 

If you have any questions about this (or any other) issue; or would like to speak with a counselor, please send an e-mail to [email protected] .  We will put you in touch with a counselor and help you the best way we can!

How Does a Credit Card Work?

The bank will pay for the item that you want to buy and then rely on you to pay them back at some point in the future.  They do this, because (by using the card) you promise to pay the balance due within 30 days. You can take longer, but (in order to be able to continue to use the card) you have to pay the interest that they charge on the money that you still owe for each month that you still owe a balance.  Each month you don’t pay the entire balance, more interest is added on to the money that you already owe.  If you miss a payment or go over the card’s dollar limit, the bank will charge you fees.

Legally speaking, the bank is called the ‘issuer’; you are the ‘card holder’; and anyone that you let use the card is called an ‘authorized user’.  There is a written agreement that the bank sends to you, after you get the card that spells out the rules for the card in really small print.  Every once in a while, the bank will change the agreement and send you a new one.  The print will be just as small and very few people take the time to read it.  However, you are bound by the agreement’s terms, whether you read it or not.

Every time you use the card, you will sign a receipt that says something like “I agree to repay the balance due, according to the terms of the Credit Card agreement”.

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Department Store Credit Cards

Credit cards don’t always have to be issued by a bank.  Some cards are issued by department stores.  Those cards are only useful, when you use them to buy things from the department store whose name is on the card.  Department stores love for you to use their cards for two reasons: first, they can charge you an interest rate that is much higher than usual; second, the stores don’t have to pay what is called an ‘interchange’ fee to the credit card companies if you use their card to make your purchase.

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Department Store Card Vs. Visa/MasterCard…What’s the Difference?

The interest rate is the biggest difference (and, it’s the biggest reason why you should think twice about using a Department Store card).  In order to get you to apply for one of their credit cards, department stores will offer a ‘point-of-sale’ (or an ‘instant credit’) offer as you are checking out.  When the cashier sees that you don’t have a credit card from that store, he or she will say “if you apply for our credit card now, you’ll get 20% off the price of your purchases today!”  You’ll be thinking, ‘this is pretty sweet. All I have to do is fill out an application, and I’ll get money off!”

However, what they don’t tell you is that the interest rate that is used by Department Store cards is usually in the high teens, or worse (18% – 22%).  And, since most people aren’t able to pay off the balance on their credit cards quickly, you will be paying a huge interest rate for each of your purchases.  Before you say yes to the credit card offer, ask them “What’s the interest rate on that card?”  If the answer is either “I don’t know” or if the interest rate is higher than the credit card that you already have in your wallet – tell them never mind!  

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Does The Interest Rate Affect My Ability To Use The Card?

The interest rate won’t affect whether you are allowed to keep using the credit card.  Usually, the only thing that will determine if you can still use the card to buy things is whether you are up-to-date on your payments.  If you are not behind (and the total amount that you owe is not above the credit limit) your card will still be good.  But, this is an even bigger reason why you should care about how high your interest rate is.  Because, while a high interest rate will not stop you from using the card, it will determine how long it will take you to pay off the balance.

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Interest Rates

When you sign up for a credit card, one of the most important aspects is the interest rate that the lender is going to charge you.  Most people don’t think that the interest rate is important.  You may be thinking, “Hey, I have a credit card. That’s all I care about.”  But, if the interest rate is too high, you might wish that you didn’t get that credit card, after all. 

The interest rate on a credit card is set by the bank that issues the card and is determined by the bank’s desire to make money.  Most people think that the Bank will look at your credit score and then give you the lowest rate that they can.  Sadly, that is not true.  The higher your interest rate is, the more money the bank makes.  So, the interest rate has more to do with what the bank can get you to agree to than anything else.  That is why it is very important for you to understand that the interest rate affects the money that you have to pay every month.

It is also very important for you to ask what the interest rate is, when you sign up for a new credit card and why you should call the bank every chance that you get and ask them to reduce the interest rate on your card, if it is high.

Look at the chart below to see what the interest rate does to the money you have to pay to the bank every month:     

INTEREST RATES and MONTHLY PAYMENTS

If your interest rate is 10% 18% 22%
Outstanding Balance Monthly Interest Payment Monthly Interest Payment Monthly Interest Payment
$2,500 $20.83 $37.50 $45.83
$5,000 $41.67 $75.00 $91.67
$10,000 $83.33 $150.00 $183.33
$15,000 $125.00 $225.00 $275.00
$20,000 $166.67 $300.00 $366.67
$30,000 $250.00 $450.00 $550.00

The numbers in red tell you what amount of your monthly payment will go toward paying the interest that is due on the balance that you owe. (Keep in mind that the credit card companies scrape the interest and any fees that you owe off the top of the amount that you mail them, before they apply anything to the actual balance that you owe).  This means that if you just pay the interest amount every month and keep using the card, you will NEVER pay off the balance.

Many of the ‘Monthly Interest Payment’ Amounts above are too high for many people to afford.  So, be careful when you apply for a Credit Card!  Your first Question should be: What is the Interest Rate? 

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How Important Is It To Pay On Time?

VERY IMPORTANT!  Other than the interest rate, this is probably the most important aspect of your credit card.  Watch those due dates!  Every credit card has a penalty for missing the payment due date. What happens if you make a late payment? The card company will raise your interest rate to a higher interest rate, called the ‘Default Interest Rate.’  The Default Interest Rate is always more than you were paying and usually somewhere above 20%. 

How do you avoid paying the ‘Default Interest Rate’?  One way is to pay the minimum payment, on the day that your bill arrives in the mail.  (Only if you can afford to, of course)  Then, put the bill away and make your monthly payment, like you normally would.  That way, you won’t miss the due date and get charged the nasty default interest rate.  (another way is to pretend that the bill is due a full week before it is actually due, and send your payment to them by that date)   Or, you can use another system that works for you and your budget.  The point is that you must do all that you can to stay current with your credit card bill.

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Everyday Items (Candy Bars, Grocery Shopping, Etc.)

Many people use their credit card to buy ‘small ticket’ everyday items. (Candy Bars, Newspapers, Snacks, etc.)  This is very convenient, but not a very good idea.   If you carry a balance on the card from month to month you will end up paying for those small items for a long time. (until you pay off the entire balance on the card, you are ‘carrying a balance’. This is just like it sounds, at the end of the month, you are literally carrying the unpaid balance on your credit card with you)  In other words, you will be paying way more than the price of those goods, because you will be getting charged interest on the balance due, until it gets paid. 

Why is buying everyday items with a credit card such a bad idea? Because, even though you are only buying small items with your credit card, it will add up fast, if you do it regularly.  The interest on one small item may not be a lot. But, let’s say you buy $10.00 worth of candy & pop at the gas station once a week; and buy a $10.00 lunch at work twice a week.  That means that you will have an extra $1,560.00 on your credit card every year, PLUS interest.  ($10.00 candy + $20.00 in lunches X 52 weeks = $1,560.00) 

Here’s a Rule to follow, if you can:

If it’s less than $20.00, keep your card in your pocket and pay cash. 

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Should I Sign Up For Every Credit Card Offer I Get In The Mail?

Probably not.  But, decide for yourself.  Before you complete the application and get a new credit card, there are several questions that you may want to answer:

Of course, the first question that you need to answer concerns the interest rate.  Many cards start out at a low rate of interest, only to jump up after a short period of time.  The interest rate for the ‘new’ credit card is certainly going to be in the written offer for new card, somewhere. But, instead of relying on your ability to read the fine print, call the company that sent you the offer and ask them: “what is the interest rate going to be on this credit card?” And don’t forget to ask them: “Is that rate going to change?”

Once you hear what the interest rate is going to be, figure out if it is higher than the interest rate on the credit card that is already in your wallet.   If the new card has a higher rate, it’s probably not a good idea.

Also ask yourself: Do I have enough credit cards now?  Remember, the bank is offering you another credit card because they want to make money, charging you interest and fees; NOT because they love you and want you to have more cards.  Are you considering a new credit card because the bank says that you need one, or because YOU think that you need one? 

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Never Use Your Credit Card To Get Cash

There are a number of very good reasons why you should NEVER take cash out with your credit card:

NEVER USE YOUR CREDIT CARD FOR CASH REASON #1: The interest rate that credit card companies charge on cash withdrawals is so high, it should be illegal.  That interest rate is NOT the same rate that is charged for your regular purchases and is almost always 25% or higher. 

NEVER USE YOUR CREDIT CARD FOR CASH REASON #2: When you make a purchase, you have a 30 day grace period, before interest is attached to the amount due. But, when you take cash out, using your credit card, the interest starts running from the moment the money leaves the machine.  So, not only is the interest rate way too high; but, the credit card company doesn’t let you pay the balance off, without getting charged interest.  Which brings us to the third reason….

NEVER USE YOUR CREDIT CARD FOR CASH REASON #3: Even if you could afford to pay back the cash that you took out right away, almost every bank requires you to pay off ALL OTHER BALANCES, before they will apply the money that you send them to the balance created by the cash withdrawal.  In other words: the only way to avoid the way-too-high interest rate that they charge is to pay off the entire credit card balance first. (Keep in mind that very few people can afford to do this) When you aren’t able to pay the entire balance off, you will be charged the way-too high interest rate on the amount that you took out in cash for a long time.

Here’s an example:

Let’s say you REALLY need $600.00 and decide to take cash out from your credit card that has a ‘cash-withdrawal rate’ of 25%.  If it takes you two years to pay off the entire balance that is already on the credit card, before you take out the cash (in other words, it takes you 2 years to get the balance down to zero), it will be TWO YEARS, until any money that you pay to the credit card company will be used to pay off the $600.00 that you borrowed.  By that time, the total balance due will be close to $ 900.00 !  

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How Long Will It Take Me To Pay Off My Balance?

Sometimes it helps to know exactly how long it will take you to pay off your credit card balance. Many people are shocked to learn that if they stopped using their credit card today (meaning: they don’t add any more money on to the balance that they owe), it would still take them years to pay off the credit card company.  Most people are unable to stop using their credit card altogether.  But, if you saw how long you have to make monthly payments to the bank, you might just charge a little bit less on that card of yours. 

The Federal Reserve has an online calculator that will tell you how long it will take you to pay off your credit card balance, depending on how much you pay every month. 

It will help you figure out:

  • How long it will take you to pay off the balance, if you just make the minimum payment
  • How long it will take you to pay off the balance, if you pay the same amount every month
  • The minimum monthly payment you will need to make if you know how many years you expect to be paying
  • The total amount of interest you will pay, however you pay it back

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Protect Yourself

  • When you get your credit card bill each month, look at every single charge on the bill to see if it is correct
    • Was that a charge that you made?
    • Is the amount correct?
    • If the answer to either of these questions is NO, call the credit card company right away and tell them that there’s a problem
  • If the interest rate on your card is more than 10%, call the credit card company and ask them to lower the interest rate on your card.  If they don’t, ask if you could do anything to make them do so.
  • If you have more than one credit card, start using the one with the lowest interest rate.
 

What’s the law?

The Fair Credit Billing Act (FCBA), is the Federal Law that tells the credit card companies how to handle a complaint that you have about your bill.  The FCBA covers:

  • Charges for stuff you didn’t buy; stuff you bought, but it came damaged; credits that were not made to your account; billing errors.
  • If you dispute a charge in writing within 60 days after you get the bill, they have 90 days to investigate and get back to you.
  • The banks have to:
    • Give you two weeks to pay the bill, after it’s mailed;
    • Report any disputes you have to the credit agencies.