The Credit Card Rosetta Stone
For hundreds of years, the best scientists in the world studied hieroglyphics to try to understand exactly what they meant. Some experts were confident they knew what the picture language was saying, while others simply shrugged and made their best guess. And then the Rosetta Stone was discovered and everything became crystal clear. On one rock was the ancient language of Egypt translated into several other languages. When a young adult gets their first credit card bill, it can seem like they are staring at a foreign language, too. The almost complete lack of personal finance education in the schools and at home has made for an entire generation that is practically illiterate when it comes to credit card terminology. But don’t fret, here is a quick primer so you can better understand the strange language that credit card companies speak.
Let’s start with the dreaded annual fee. If there is one truism that rings true throughout the universe it is that credit card companies love their fees. One of the most popular and most common fees is the annual fee. Sometimes, an annual fee will present itself under the name “membership fee” or something similar. It is usually charged once per year and just added right to your credit card balance. You find these pesky fees on cards of all shapes and sizes, but they are the most common on cards that are either really, really good, or really really bad. What does that mean? Things like gold cards and platinum cards will often have membership fees to pay for all of the extra services they offer, while sub-prime cards, or cards that are given to folks who have worse than normal credit will often have annual fees to offset the cost of defaults and write-offs. Ideally, you want to avoid the annual fee card, unless the justification for the fee is that the card delivers an outstanding service in return.
One of the most important terms that is thrown around in credit card parlance is APR or annual percentage rate. The APR on your card is essentially the interest rate you pay. The lower the number, the better off you’ll be. Credit card applications are required by the letter of the law to tell you exactly how much you are required to pay in APR. Just flip your credit card application over and read the graph on the back. Another important tip when it comes to your APR is looking to see if your credit card company plans on changing the interest rate you are being charged. Even if your APR is fixed, your card company can still change your rate. They simply have to give you one-month’s notice so that if you do not want to go along with the new rate, you can cancel your card, pay off your balance and be done with the card. The card companies like to slip these little notices in with your monthly bill, and most people don’t notice them until its too late and next months bill has arrived. Don’t let them slip it past you, read everything that comes with your bill every month.
The next term we’ll look at is average daily balance. Average daily balance is a somewhat complicated mathematical formula that your credit card company uses to come up with how much interest to charge you every month. This is how it works. The credit card company takes your balance every day of your billing cycle, adds them all together and then divides them by the number of days in a billing cycle. You then take the daily periodic rate and multiply it. It sounds complicated, but it really isn’t. Here is an example so you can see it more clearly. Let’s say that your interest rate is at 20 percent. Divide 20 percent by 12 and that gives you a daily rate of 1.66. If your average daily balance is $2,000, your interest that month would be $33.20 that month. When you start to get into mathematical equations, people tend to get nervous and start having flashbacks to middle school and high school algebra classes, but a basic understanding of how your card company figures your interest is quite helpful when it comes to managing your credit cards right.
If you have had your cards for a while, you probably have noticed the term Balance Transfer come up more than once. A balance transfer is when you take the balance on one card and transfer it to another card. People do this mostly to save on interest rates, but balance transfers can be tricky because the rate on the new card, while it may be lower at first, is usually an introductory rate that doesn’t last very long. If you don’t read the fine print, you could get stuck with an even higher rate or, at the very least, the same rate you had in the first place. Some card companies charge fees to transfer balances over, some don’t. If you are thinking of taking advantage of a balance transfer, make sure you read the fine print first and call the credit card company and ask questions if you don’t understand something completely.
Maybe the most common fee of all that is attached to credit cards is the cash advance fee. On almost all credit cards, you can take cash out at an ATM (once you set a PIN) or with those handy little checks they send you. If you do take out cash, be aware that most card companies charge a fee. It is either a percentage of whatever you end up taking out, or a flat fee, anywhere from $10 to $30 every time you take out cash off of your card. It is widely considered to be a “last resort” sort of transaction because the fees are so high. The fine print on cash advance fees varies for every card out there so many sure you understand what your card is asking before you follow through.
The credit limit on your card is simply the maximum amount that you are able to charge to your card. Every card has a different limit and each card has different penalties for overspending your limit. When you first start out with credit cards, you don’t have a credit rating to speak of, so most credit card companies are going to give you modest cards with credit limits that usually don’t exceed $1,000. As you get a little older and you use your cards responsibly, you’ll get offers in the mail for other cards with increasingly higher credit limits, or your current card will mail you notices that they are raising your credit limit as a reward for keeping your account in such good shape. Some gold card or platinum card holders today actually have no limit at all, but these cards are extremely rare. One exception to the credit limit rule is American Express. The original green American Express card that we all know actually has no limit, but unlike MasterCard, Visa or Discover, you are not allowed to carry a balance on your card. That means you are required by American Express to pay off the entire card balance every single month. American Express has since come out with their Optima card, which works more like a traditional card that has a set credit limit and allows you to carry a balance.
The biggest enemy of the credit card user is the finance charge. A finance charge is simply the cost of using the credit card. Most card companies will charge you once per month but every card is different. The finance charge is made up of the interest you accumulated on your balance, plus any fees that come with your account, like an over-limit fee for exceeding your credit limit or an annual fee that you pay once a year. Some cards actually allow you to escape most finance charges if you pay off your entire balance every month, but other cards have started charging you a separate fee for doing exactly that since they feel that they aren’t making enough money off of you otherwise. Before you apply for a credit card, check the full disclosure listed on the back of the application. All finance charges and fees must be listed on the back of every application by law. This way, there won’t be any surprises come your first billing cycle.
One recent trend in credit cards is to give you one set of finance charges for new purchases and a whole other set of finances charges for balance transfers. If you are breaking in a new card that you transferred a balance to, make sure you understand the way the card works before you start spending.
Most credit cards come with a grace period. A grace period is the time when your credit card is not accumulating interest. For most cards, this only happens when your card does not have a balance on it, like when you first activate it and you haven’t used it yet. Other cards allow a short grace period after every purchase of 4 or 5 days before they start charging you interest on your purchase. Other cards start charging you interest right away as soon as you make a purchase. Every card does their grace period differently, make sure you understand your card’s grace period before you apply for it. It can make a big difference in the amount of interest you have to pay every month.
Of all of the fees that are attached to a credit card, the one you want to avoid the most is the late fee. You are charged a late fee when you make a payment after the payment due date. In the olden days, this happened frequently because of uneven mail service. You would get into a habit of mailing your payment a certain number of days before your due date and most of the time it would get there in time, but there would always be one month when it didn’t, and you were left with a big fee (it is usually anywhere from $20 to $40) on your account, and sometimes, a much higher interest rate. One of the biggest scams associated with credit cards, especially ones given to people with poor credit or those without an established credit history is to crank up your interest rate to the maximum allowed by law (usually 23.99%) the first time you make a late payment, even if they get your payment the very next day. Obviously, this is something you want to avoid at all costs. These days, with the ability to make payments over the Internet, even with a personal check if you don’t have a debit card, you have even fewer excuses for racking up late fees. It can not be stressed enough how important it is to make your payments as soon as you get your statement in the mail or in your email, and to pay off as much of your balance as you possibly can every single month. It is the single biggest part of maintaining a healthy credit rating.
Along with the plethora of fees your credit card charges, their favorite part of the credit card is the minimum payment. The minimum payment will be listed on your credit card statement and this number is the lowest amount you can pay towards your account without accumulating any extra fees. If it is at all possible, you should ALWAYS pay more than the minimum. While every card is different, the minimum payment is usually two percent of your balance. If you only pay your minimum every month, it will take you a very long time to pay off your card balance.
If there is one truism that rings true no matter which credit card you use, it is that they love fees. Credit card companies make plenty of money off of their monthly interest rates, but credit card companies are greedy and want to siphon even more money out of your bank account. One of the ways they do this is with an over the limit fee. Every credit card (with the exception of some gold and platinum cards and the original American Express card) has a set credit limit that you cannot exceed. For most beginner cards it is around $1,000, and it goes up assuming you keep your credit in good shape. But when you “max out” your credit card, or reach the spending limit, you run the risk of going over your limit and incurring a fee. When you reach your limit, one of two things will happen: your card will be declined when you try to use it, or the transaction will go through and you will be assessed a fee. In most cases, if you are allowed to exceed your limit, you will only be allowed to do it once, and then all further transactions will be declined until you pay your balance down below your limit. While every card has a different over-limit fee, they tend to range between $20 and $50 dollars. Make sure you understand how your card’s over-limit fee works before you apply for it. It can save you a significant amount of money.
The payment due date of your credit card is an item that has caused much consternation among credit card holders. When most people sign up for card, they believe, falsely, that as long as their check is postmarked by the payment due date, they will not be charged a late payment fee. They are almost universally wrong. The payment due date for your credit card is the date in which the card company must receive your payment by. And since the mail system isn’t exactly reliable most of the time, you should allow AT LEAST 10 business days for your payment to get to the card company. And for those of you looking to pay online with your debit card, don’t assume that the transaction goes through instantly. While in this day and age of computers and instant email, one would think the transaction would be instant, but in fact, the processing time can take up to 3 days in some cases. Do not wait until the day of your payment due date to make an online payment using your debit card. The biggest reason why you need to watch your payment due date is that some card companies have been known to crank up your interest rate as a penalty for missing a payment. This can cost you thousands of dollars in interest over the life of your card.
One term that the vast majority of people don’t understand is your periodic rate. While the term sounds a little confusing, it isn’t. Your periodic rate is simply your interest rate spread out over a period of time. You can have your interest figured out on a monthly basis, which means you have a monthly periodic interest rate, or if your card company uses a daily rate, then you have a daily periodic rate. Most card companies use the daily rate to figure out how much interest to charge you. The most important part of your periodic rate is the lower, the better. The less interest charged to your account every month, the easier it will be to pay off. But be careful when it comes to introductory periodic rates. Some cards will use low, temporary rates to entice you to switch to their card, but it is the rate that takes effect after the introductory rate expires that really matters. If the real periodic rate after the temporary rate expires isn’t any lower than the one you have now, there isn’t much of a point in transferring your balance.
When you get your first credit card statement in the mail, it can be tough to understand what all the numbers mean. One of the terms that often appears on a credit card statement is the previous balance. The previous balance is simply the amount you owed to your credit card at the time of your last statement. This number will not include the most recent payment you made. Often times, your statement will show your previous balance, then underneath that, your last payment, then finally, the new charges to your card this month and the interest and fees with the number at the bottom being your current, up to date balance. Remember, your previous balance is not what you owe right now, your statement is simply showing you the evolution of what you owe over the last 2 months.
On a line below your previous balance, you will often see a line for new purchases or new charges. This line shows every new purchase on your credit card. It is extremely important to check this part of your credit card statement carefully because this is where any charges that might not have been made by you would be listed. While the number of people who have their credit card numbers stolen is still pretty small, it does happen and if you are not diligent in checking your statement, you might not realize that someone else is using your number without your permission. That’s why it is important to take a few minutes every time you get a statement in the mail to analyze every charge listed under the new purchases or new charges section. If you see a charge that you did not make, call your credit card company immediately and tell them.
One new trend that appears to be sweeping the world of credit cards is known as two-cycle billing. With two-cycle billing, your credit card company uses an average of two months of your balance to figure out how much interest to charge you. While two-month billing does not sound like a bad thing, studies have shown that, in most cases, average monthly costs on your card end up higher. But there is something you can do if your card switches to two-cycle billing and you don’t want to go along for the ride. All card companies will send you a notice, usually along with a monthly statement, whenever they change any terms on your credit card. This notice usually takes the form of a white slip of paper that is easily missed. If you check this slip of paper, you will notice that the card company gives you 30 days to send them a written letter asking them to close your account and to keep you on one-cycle billing. The catch is, of course, if you continue to use your card after those 30 days, you will automatically be switched to the new billing style. You will have the same option if your card company tries to raise your fixed interest rate. You’ll lose the use of your card, but you don’t have to go along with every change your credit card company chooses to make on your account.
Our final term is one of the most important. A variable interest rate is simply a rate that chances once in a while in response to the national interest rate. Interest rates come in two forms: fixed and variable. It works just like the interest rate on your parent’s mortgage. A fixed rate is exactly that, fixed, although the credit card company CAN change your fixed rate but you have the option to opt out before they do it, and an adjustable rate that changes depending on what the national rates do. Many cards that offer balance transfers these days offer a fixed rate on the transfers and then a normal, variable rate on new purchases. For some high end cards that want to keep you as a customer because you tend to be a bit of a high roller, they can sometimes offer a fixed rate on all purchases and transfers, but these kinds of cards are extremely rare. If credit card companies offered fixed rates on all their cards, they could end up losing a significant amount of money if rates took a tumble in the wrong direction.