This is a guest post from Justin McHenry, president of Index Credit Cards, a credit card comparison and information site. Index Credit Cards was named “most comprehensive” by Reader's Digest in its October 2008 issue, and regularly cited by both old and new media.
True or False? Credit card companies lure you in with big promises, but bury the nasty stuff in fine print.
It would be hard to find many people that disagree. Unfortunately, when the consensus is that card companies are out to get you, you might be tempted to throw up your hands and give in, saying “What can I do?” If that's your attitude, you can be sure they'll take full advantage.
Because you read Get Rich Slowly, though, I'm guessing you're a little more savvy, a little more proactive about your finances, a little more likely to look before you leap. So, let me give you five specific things to watch out for, both when getting a credit card and when using the card you have, and how to avoid each trap.
Promise #1: “As low as 9.99% APR!”
The Trap: Your interest rate could be as low as 9.99%… but it could also be as high as 20.99%, or whatever the card company has put in the fine print.
Your Plan: Read the “Schumer box” (where the interest rate is shown in larger type, usually on the reverse side of an application) to see if the card company has allowed themselves the luxury of giving you any interest rate they please. If yes, either consider your credit history and go in with your eyes wide open to the possibility of a higher rate, or choose a credit card that offers a single take-it-or-leave-it rate. In that way, you're either approved or rejected, but you don't come away feeling fleeced.
Promise #2: “Up to 5% cash back!”
The Trap: Several. The card may offer you much less than the 5% rebate until you spend a certain amount per year. On the flip side, it may give you a 5% rebate for the first $300 in purchases each month, then drop the rebate down to 1% or less.
Your Plan: Stay away from cards that market a rebate “up to” a certain percentage, and go for those that promise a “full” percentage. And check the fine print for caps on monthly or yearly rebates.
Promise #3: “0% APR on balance transfers for 12 months!”
The Trap: Two-fold. First off, it's almost impossible these days to transfer a credit card balance without paying 3% of the balance upfront. Transfer $5000 and you'll pay $150 before we even start talking about paying down the balance.
Second, almost all card companies take your payments and apply them first to balances with the lowest interest rate. Say you transfer $1000 to a card at 0%. The card's interest rate on new purchases is 13.99%. This month you buy $500 worth of stuff with the card, then pay $500 when the bill comes. Do you still have a $1000 balance at 0%? No, you have a $500 balance at 0% and a $500 balance at $13.99%! Why? Because your $500 payment went toward the balance sitting at 0%, not toward the balance sitting at the 13.99%.
Your Plan: A couple of options. The easy thing to do would be to swear off credit for a bit — transfer the balance then don't use the card until it is paid off. (You'd stilll get hit with the 3% fee, but it might be worth it if you had a high interest rate on your old card.)
If you have decent credit and a little more self control, you could get a new credit card that offers a 0% rate on purchases for 12 months, then use it while you pay off your old card's balance. By doing so, you focus on paying off your high-interest debt while floating new purchases at 0%. If you follow my logic, this is very similar to transferring your balance at 0% but without the fee. Either way, recognize that the 0% rate doesn't last forever and the bill eventually comes due.
Promise #4: Your card has a credit limit of $3000.
The Trap: While logic would tell you that your card company won't approve purchases beyond the limit, the reality is that they will let you charge beyond your limit, then slap you with a $39 fee to penalize you.
Your Plan: Don't think of your card company as a caring parent who cuts you off when you overspend. It's up to you to keep track of when you get close to your limit. (By the way, you really should not be getting that close to your card's limit. It's hell on your credit score.)
Promise #5: “Any time for any reason”
The Trap: Unlike the other promises, this one's too nasty for the issuers to put a positive spin on, so it stays tucked away. In short, in almost every card agreement, the card issuers give themselves the right to change your interest rate at any time for any reason, even if you've done nothing wrong. And they only have to give you 15 days notice, so you could find yourself scrambling if it happens to you.
Your Plan: Have a second credit card before this happens instead of waiting until you're in trouble. You don't ever have to use the second card, but the last thing you want is to have your interest rate jacked up to 25% with no recourse if your credit card issuer decides to play hardball.
Credit cards ain't for fools. If you're going to carry one, then take responsibility for understanding what you're getting into, and fight fire with fire when your card company decides to play rough.