We are seeing many people trying to clear up their most expensive debt, the vast majority of which comes from credit cards. People get into a lot of trouble by not understanding what credit cards do and how they work. The following are 5 simple facts about credit cards.
1. High Interest Rates - They charge higher interest than bank loans because they are easy to acquire, and the credit card companies don't have your house or vehicle as collateral. In order to make up for this increased risk of no collateral, they charge higher interest rates. The standard card today charges around 18.9%, with some store cards charging as much as 28%. There are lower rate cards around, but the low rate is usually an introductory offer and increases to regular rates after 6 months or a year. A good credit bureau score can get you a better rate.
2. Payment Calculations - Most credit cards charge interest monthly and require a payment of 2% of the credit card balance each month. If you owe $5,000 on a card that is at 19% annual interest, your interest payment is around $79, and your principal payment is $100, which means you must pay $179 as a minimum payment to the credit card company. The following month, if there were no further purchases, the balance of $4,900 would have an interest payment of $77.50 and a balance payment of $98, for a minimum payment of $175.50. While $175 may seem manageable, the problem is so many people don't stop at $5,000 on a credit card. Those small amounts add up very quickly.
3. Grace Period - Some credit cards offer about 21 days after your purchase before they start applying interest. Most start applying interest the day of the purchase, unless you pay the card balance off in full by the due date. For specific details you need to look at your own card's details.
4. Cash Advances - Cash advances count as withdrawals off a credit card, whether through an ATM, in branch, credit card convenience cheques, and often advances at casinos. Cash advances often have fees, usually ranging from $2 to $5 for each advance, plus interest starts being charged on the amount the day of the advance. Some cards charge a higher rate for cash advances than regular purchases, so you will want to check the details on your cardholder's agreement before you use it that way.
5. Missing Payments - Because the credit card companies do not have any physical security on your credit card loans, they not only charge high interest rates but they also have stiff penalties if payments are missed. Most cards will raise your interest rates if are late or miss a payment. Rates for a late payment rise from 2% to 8%, depending on the card issuer. They also report to the credit bureau if you missed a payment due date. This then shows up for all financial institutions to see. One miss is not bad by itself, but if there are multiple late payments over a few years, it can lower your score enough that you may no longer qualify for loans, or your rate is increased by lenders.
The credit card is very useful. Online purchases, hotel bookings, and emergency usage (vehicle repairs) are perfect for credit card usage. People get into trouble as they start using the card and not paying it off quickly. That goes into a discussion on budgeting, which has been written about on this blog previously, but it is a lesson that never stops. If you have any questions about credit cards, please let me know. Jerry
The credit card may simply serve as a form of revolving credit, or it may become a complicated financial instrument with multiple balance segments each at a different interest rate, possibly with a single umbrella credit limit.
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Credit cards are handy, but too many people can't control themselves when they have easy access to money. They have to spend until they have reached their maximum. It's a hard lesson to learn that you have to control your spending, and unfortunately for the past 2 generations it isn't a lesson they learned while still young.
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