Credit Card Interest
Interest Rate - high rates are high rates.
Credit card interest works just like interest on other loans. So why have a special section for it?
In a word, the interest rates are really high. As of the date this was written, the average interest rate for student credit cards stood at 16%, headed nowhere but up. Mortgages, student loans, car loans and almost all other consumer interest rates are all in the single-digits, while credit cards are well into the double-digits.
Think of it this way. It’s freshman year and you’re out and about on your own. Freedom Rules! You go to the store. You see a cool watch you really want. It costs $100. Not so much money ... but you don’t have it. So you buy it on a credit card charging you 16% annual interest.
Now let’s say you have tuition to pay, books to buy, food to eat, etc ... over the next five years. You can’t pay off that $100, so, you let it ride on the credit card. After you graduate, you’ll get a job, you’ll pay it off ... meanwhile you’re charging other stuff, making the minimum payments, but that original $100 never quite goes away.
Year 1: $100 @ 16% interest = $116.00
Year 2: $116 @ 16% interest = $134.56
Year 3: $134.56 @ 16% interest = $156.09
Year 4: $156.09 @ 16% interest = $181.06
Year 5: $181.06 @ 16% interest = $210.03
Interest just doubled the cost of your watch ... And that’s IF you pay it off now.
Now for the really bad part - our example isn’t actually correct. Credit cards usually calculate your interest on an average daily balance. They accrue your interest once a day or once a month, not once a year like we did here. Doing that keeps our example simple, but also means our number is low - it would actually be more than $210.
Low Payments
Credit cards also offer fairly low monthly payments; far lower, proportionally, than a car loan or a mortgage. This means that if you only make the monthly payments, you will often incur thousands of dollars in interest, and take many years to pay off the card. Some cards even allow interest-only minimum payments, meaning you will never pay off the card at the minimum payment. That’s never as in ... well ... never!
What’s my Rate Again?
Here’s another reason to talk about credit card interest separately. Unlike other interest rates that are often fixed (same right for the life of the loan) or variable (based on a financial index and a set formula), credit card interest can vary for many reasons. One of the most common is an "adverse" rate. This happens when you’re late on a payment or otherwise have an "oopsie" with your card. Written in the fine print you signed when you got it, there’s a clause that allows them to raise your rate - some cards as high as 29% or more - if you do that. We’ve even heard reports of some credit cards raising your rate if you’re late on other credit cards!
Late Fees
That’s not to mention late fees. Many credit cards charge a substantial late fee if your payment doesn’t reach them in time. Simultaneously, they sometimes use irregular billing periods (e.g. every 21 days rather than every month) that can make it quite difficult to always pay on time. If you have a $250 balance and get charged a $25 late fee one month, that’s like 120% annual interest!
You’re probably thinking this makes those new "no late fees" credit cards a good idea, huh? Well, remember what we said about "adverse" interest rates? Remember how we said some companies will take your rate to over 29% if you pay late? Read the fine print if you get any "no late fees" card offers. Betcha that "if you’re late" rate is scary. Just because there’s no "late fee" doesn’t mean there’s no cost to being late.
Benefits of Credit Cards
We’ve said before and will repeat here. Credit cards don’t create debt, people create debt. Credit cards do have advantages and benefits, when used responsibly. They can allow you to better track your expenditures. They can allow you to make purchases when you’re not physically there (e.g. on the Internet). They can allow you to spread payments over time (for a price). They often offer "buyer assurance" features ensuring you have some recourse if an item is lost, stolen or doesn’t work right. And, using them wisely improves your credit score! We are NOT saying to skip credit cards.
What to Do
You must do several things to use credit cards rather than letting them use you.
- You don’t have to take the credit limit they give you. If you think the credit limit is more than you can responsibly handle, call and ask to have it reduced to a comfortable level.
- Read, read, read the fine print. We know it’s a pain. We know it’s no fun. We know you want to sign off and get that instant approval. Don’t do it! The fine print is where little bogeymen like "your rate goes as high as 29% if you’re late" live.
- Consider all the factors. Do you want a card with no annual fee, or higher rates? Do you want a card that earns you points or miles, or one with a lower rate? Do you want a card that doesn’t charge late fees, but has a very high interest rate cap?
(Consider carefully and work on the assumption there’s no free lunch. We have yet to find a no-annual-fee card with the lowest possible rate and a points program and no late fees and no hidden interest rate "gotchas.")
- Last but now least, we know it feels an awful lot like free money. It isn’t. Yeah, you see that _____ (stereo, dress, album, concert tickets, night out at the pub) that you just have to have. You need it! You deserve it! And, with one little swipe it’s all paid for. It’s kind of cool. It’s kind of fun. It’s definitely tempting. But it’s not free money. It’s actually very expensive money. Remember our $100 watch that cost us $210?
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