Credit Card Gotchas: A Primer

Credit card rules have changed with the CARD Act of 2009, but despite the perception that credit cards are now more consumer-friendly, a lot of the credit card “gotchas” still remain the same. Here are my favorites:

most people don’t know this, but subprime credit card lending is really driven by fees, rather than interest charges. Since issuers make more money when you screw up than they can make from interest, they’ve consistently created fees to maximize the money they can collect before the borrower defaults. Some of the worst problems have been eliminated with the Act, but here are a few that can still get you:

• Late fees: Yes, the trickery is gone but you will still get charged late fees if you’re late. You get 21 days to make payment, but many people don’t pay attention and miss payment. Don’t be one.
• Over-limit fees: you can still be charged up to 3 over-limit fees per billing cycle. You can avoid any, by setting a fixed credit limit on your account that cannot be exceeded. Your purchase will be denied, but your issuer can’t charge you fees.
• Annual fees: the CARD Act limits the size of annual fee that can be assed for low-limit cards. However, many cards carry annual fees over $80.

Long payoff horizon: The CARD Act did change some rules here—they have to give you 45 days’ notice before raising rates, they have to apply payments to your highest rate balances first, and they have to clearly disclose how long it will take you to pay off if you make minimum payments. All great, but it doesn’t change how long it will take you to pay it off, even if you follow all their rules.

Credit cards generally have a minimum payment calculation that works out to around 2.5-3.0% of the balance. So if you had a $10,000 balance at 18% interest, a 3% payment works out to $300 per month, with $150 going to principal. However, what happens to this payment as you pay off your balance? At $5000, your payment is only $150, which seems like a good thing, but you’re only paying off $75. In essence, you pay off less and less each month which is why it can take 25 years to pay off the balance. Installment loans with a fixed payment like auto and mortgage have the opposite effect—the size of the principal payment goes up each period as the balance (and therefor the interest amount) comes down. In fact, if you treated a credit card like an installment loan, you can have it paid off in 4 years and pay half as much in interest.

Balance transfers and low intro rates:  The CARD Act set prohibits issuers from raising your rates without reason and sets limits on how issuers can raise your rates. And yet, for most of us, the challenge isn’t when our interest rates go up, it’s when they go down.

Most of us feel smart and satisfied when we do a 0% transfer or get a low intro rate—after all, we’re beating credit issuers at their own game. But credit card companies are willing to spend a lot of money to get new card holders with balances. Thy run complex models designed to figure out which marketing “cells” or groups of customers should get specific target offers that will get them to actually drive up their borrowing and pay more in interest. They hire Harvard MBA quant jocks that run models all day and they conduct thousands of tests to see how they can get new cardholders to sign up and get current borrowers to borrow more. They spend millions of dollars every year.

Still think you can beat them? Maybe, but probably not. They are very certain that enough of their customers will be fooled by the offer and that they’ll make a good return.

So although the CARD Act made some great strides in protecting consumers from some clearly egregious terms, for credit card issuers, the game remains very much the same. As always, you should stay vigilant and on-top of your finances and of course try to pay off consumer debt as quickly as possible.

Fees: