Taming the Credit Card Beast

Apr 03, 2003 |Todd Temple

Easy credit abounds — especially in college mail boxes. So how do you balance all that quick money with the potential for staggering debt? Glad you asked.

The invention of the credit card has got to be one of the all-time great moments in the history of money.

With a major card you can travel just about anywhere in the world and purchase things in the local currency without carrying cash. You can order something over the phone or Internet and have it delivered to you the next day — or the same day, in some cases — simply by giving someone your account number. And if you're willing to leave a credit card imprint at a car rental counter you can drive away with a $40,000 automobile, then give it back the next day, no questions asked. What a world.

But this amazing device is also one of the most dangerous inventions in history. Its ability to let you buy now and pay later has led millions of otherwise thrifty people into financial captivity, forcing them to spend years, or decades, or a lifetime in debt.

Of course, it doesn't have to be that way. It's possible to reap the great benefits of a credit card without ever paying a dime in interest. This month we'll look at that other way: How to tame a credit card so that it provides you with all the conveniences but none of the debt.

Card Shopping

Before you shop with a card, you must shop for one. As I've covered in this column recently, the best credit card for our purposes — convenience rather than consumer debt — is one with little or no annual fee and a long grace period. Let's look at each of these qualities in turn.

Technically speaking, an annual fee is a finance charge — a cost of paying for something with someone else's money. This particular type of finance charge purchases the privilege to borrow that money simply by using the card . . . and you pay for this privilege whether you use the card or not.

Let's say that over the course of a year, you use this privilege to make a total of $500 in purchases. You pay every credit card bill in full within the grace period, so there's no interest to mess with. But if the card comes with a $50 annual fee, the cost of these "interest free" loans is 10 percent. And if you charged $1000 on the card, the cost drops to 5 percent. That's not a bad rate as far as cards go, but it's a finance charge nonetheless, and finance charges are something you want to avoid.

To do that, you'll want to shop for the card with the lowest annual fee — or no fee at all. The good news is, the average consumer is very sensitive to annual fees, so lots of card issuers do indeed offer cards with no such fee. They figure that if discarding an annual fee attracts customers who spend twice that amount in interest on unpaid balances, they win in the end. Which means that you profit from the bad habits of others: You get your borrowing privilege for free and, when you carefully exercise this privilege, you pay no interest.

Of course, the no-interest trick is impossible if the card comes without a grace period. The grace period is the number of days you can "borrow" with your card without incurring an interest charge. Though the fine print on a credit card agreement defines this period in very specific terms, most folks consider the grace period as starting on the on the first day of a billing period and ending on the day the bill is due. If you make a charge on the first day of a 30-day billing period and your payment is due 15 days after the billing period ends, you can wind up with a 45-day, interest-free loan. If the charge was made on thelast day of the billing period, you'd have just 15 days to frolic interest-free.

But beware. Some issuers have shorter grace periods. And believe it or not, some grant no grace at all: You're charged interest the moment a charge is made. Unless digging yourself into debt is your goal, you want nothing to do with any such card. Pick a card that offers a long grace period.

There are plenty of other factors that affect the cost of using a credit card. But if you're committed to using your card wisely, they won't apply to you. Just compare cards by annual fee and grace period and go with the card offering the best deal on each. However, since those other factors do come into play when you fail to play your cards the way I'm advocating, we'll cover them so you can see their effects. But in a moment. First, we need to get something straight.

Interest-Free Isn't Free

Just in case you're worried that by paying no annual fee and nary a cent in interest you're exploiting the generosity of the card issuer who depends on these finance charges to stay in business, stop your worrying. Issuers make money whether you pay such charges or not.

That's because they've got a double-ended income stream. They make money on the back end by charging interest on unpaid account balances, cash advances and a host of other finance charges. But even if you don't oblige them at the back end, the issuer makes money at the front end by charging merchants a percentage of every transaction they process.

When you make a $100 purchase on your card at a store, the merchant receives, let's say, just $95 from the company that processes their credit card transactions. The processing company then charges your credit card issuer, let's say, $97, who in turn charges you the full $100 on your next bill. (It's a bit more complicated than this because the percentages to each party vary with the type of card, the companies involved, the amount of the purchase, and the merchant's sales volume, but you don't really want to know all that stuff, do you? I thought not.)

The result of all this tricky transacting: The store generates more sales by offering the convenience of credit cards, the processing company makes a a few bucks for serving as the middleman, and the issuer gets a cut to compensate them for the money they're letting you borrow interest-free during the grace period. Everybody wins.

Well, not quite everybody. In this example, the merchant got paid $95 for an item with a $100 price tag. Chances are, they've figured that cost into the price of the item, so you're really paying an extra five bucks for a $95 item. Maybe it's worth it: You don't have to carry all that cash around. And if you're playing with a grace period, you get an interest-free loan till the payment is due, allowing you to use that money for something else, like earning interest in a savings account.

But what if you're paying in cash? In nearly all cases, you'll pay the same price as the customer who pays with plastic — who ought to be thanking you for subsidizing his purchase (because if everyone paid with credit cards, the merchant's expenses would be greater, driving the price even higher). In some cases, the seller will offer a cash discount. Actually, they prefer to phrase it the other way: The real price is the cash price; if you choose to pay in plastic, they charge you a "processing fee." This keeps them out of hot water with the price-swap cops and allows them to advertise a price that's lower than their single-price competitors.

In any case, credit cards increase merchants' costs, which get passed onto the consumer, so convenience has its price, even when you pay no interest on your purchases. As Dad always says, there's no such thing as free.

OK, now that we've got the philosophical out of the way, let's sort out the practical: How to tame the cards you now have.

The Only Good Card is a Tame Card

In my not-so-subtle attempt to convince you that the only proper way to use a credit card is for convenient, interest-free purchasing, I avoided discussing interest rates and other factors that figure big for people who use them in that other, not-so-smart way, but make no difference to the enlightened.

Well, I've traveled that dark road, dragged by a leash controlled by my credit cards. Chances are, you have too. If you're there now — that is, you're carrying a credit-card balance from month to month — this next batch of taming tips will help you reclaim control. And if you're already in command of the leash, these tips will help you stay there.

Migrate to lower interest

If you're carrying a balance on more than one card, pay off the highest-interest card first. You might also try applying for a new, lower-interest card whose issuer is willing to assume the entire debt on an old card. But read the fine print. Many cards come with a low introductory rate that gets jacked up after a few months. If you're unable to pay off the debt before the sweet deal ends, you could wind up worse off than you started.

Make more than the minimum payment.

The minimum payment printed on your bill is ingeniously calculated to ensure that you pay the highest interest for the longest time. It's your enemy. If you can't pay off the entire balance, pay as much as you can. Every dollar shortens both the time and distance to debt-freedom.

Pay early

When you're carrying a balance from month to month, there's no grace period: You're being charged interest on the balancedaily — and each new charge on the account incurs interest the moment it's made. Eliminate some of those interest-infested days by paying the bill the moment you receive it. Better yet, send a check to the issuer whenever you have money to cover it: You don't need a bill — just include your account information with the payment.

Flee from fees

Your credit card agreement lists a host of fees and penalties that can be charged if you do something silly like send a late payment, go over your credit limit, or bounce a payment check. In most cases, these fees are just added to your balance, incurring interest immediately. The result is often compound interest: paying interest on the interest.

That's good for the issuer — charging interest on money they've never lent you is extremely profitable to them. But it's very bad for you. Avoid these fees at all cost: Make payments early and be sure that your checking account has the money to cover them. And stop using your credit card till the balance is paid off. It's much easier to stay within your credit limit if you start each billing period with a clean slate.

Toss the offers

Issuers love to stuff their bills and other mailings with offers for merchandise, credit protection insurance, and all sorts of other deals that pleasure and comfort for just a few more dollars conveniently added to your monthly bill. Throw them away. Over the years I've received thousands of these offers; I've yet to see a single good deal among them. If it's merchandise they're offering, you're sure to find a better deal on it by shopping around.

The offers for card protection provide coverage you don't need: Under federal law, your maximum liability for fraudulent charges made on credit cards is $50 per card. And by policy, most issuers won't even charge you that. Just report a missing card or bogus charge the moment you discover it.

Stay away from cash advances

With but one exception, getting cash from your credit card is always a bad idea. Unlike regular charges, cash advances don't come with a grace period: You pay interest from the moment you receive the cash. I hesitate to tell you about the exception because it's pretty rare, but if you're in this situation, you might try it: If an issuer offers you an exceptionally low rate on cash advances, and you're paying higher interest on another card or any other type of loan, it may be smart to use the former to pay off the latter.

But be careful: Some cash advances have a processing fee that wipes out the benefit. And most special rates are limited to a few months; after that period, the interest rate skyrockets to a level equal to or exceeding what you're probably paying on that other account. If you know that you can pay off the advance within the low-rate period, and the processing fee plus interest on the advance is still lower than the interest that would be paid on the other account, then go for it. In every other case, steer clear of the cash advance. It is not your friend.

Card Obedience School

If you're carrying a balance on your cards and want to end this practice as soon as possible, I've found a delightfully simple little software program that can help you. In the card-taming world, it serves as obedience school. It's called PayEmOff, it runs in Windows, and it can be downloaded for free from the PC Magazine website.

After entering the balance, interest rate and minimum payment information on each of your cards, PayEmOff shows you how various payment scenarios affect the total interest you'll pay and the time it takes to be clear of your debt. It doesn't mess with account numbers or make your payments for you: It's just a handy little calculator.

And a great motivator. When you see how long the minimum-payment scenario will last — and the obscene amount of interest you'll pay if you take this route — you'll be scared straight. Then when you compare that frightful picture to a more ambitious payment plan of your choosing, you'll see the light of debt-freedom ahead and the best path to get you there. It's worth the trip.

Copyright 2003 Todd Temple. All rights reserved.  

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