Credit cards are used by millions of consumers to make everyday purchases including groceries, clothes, and gas. Credit cards are easy, convenient, and accepted nearly everywhere. However, they are also confusing. Unless you realize the ramifications of paying with credit, you can wind up in big financial trouble.
The Credit Card Loan
A credit card purchase is really a short-term loan from a bank. Since banks are not in the business of providing free money, they charge an interest rate on purchases. Interest rates can be as high as 19% of your purchase if you do not pay your full credit card balance every month.
Ease of use is one of the biggest benefits of a credit card. Credit cards offer a line of credit, for which you pay back the balance. For this convenience, banks charge a high interest rate which compounds daily, at about .000041%, rather than monthly. The result is paying a much high effective rate of interest over time when you fail to settle the balance each month.
It doesn’t feel like a loan. One of the biggest drawbacks of a credit card is that it does not feel like a loan. When you buy a home, there is a specific and long process of loan qualification. You must produce an abundance of paperwork proving income, assets, employment, and so forth. When you close the loan, you sign dozens of a document laying out your contractual obligations for repayment.
A credit card application consists of five or so questions stating income, address, and personal information like your birthday and your social number. In less than 30 seconds you could unveil a line of credit for $5,000 or more and immediately make a purchase. Those with good credit find a constant bombardment of invitations to apply for even more credit, encouraging you to borrow more money.
Even though there may be a lack of emphasis on “The Loan” part of a credit card, that is indeed what it is. On the tiny screen where you sign your name, you agree to repay all amounts, plus high interest and fees, which can change quickly, often at the credit provider’s discretion.
Take Time To Review What You Are Signing
Credit card loans can border on predatory when default rates and late fees begin to kick in. You must read everything in front of you instead of rushing to get the in-store purchase discount because your financial life depends on understanding these loans.
Credit Card Costs
Like many short-term loans, the cost of using credit cards can be astronomical. For example, today if you cut up each and every credit card and never used them again and you made minimum payments to eliminate the debt, it might take as long as 30 years, and 3 or more times the original balance, to pay off the debt. This calculation does not include any late fees, annual fees, or other costs associated with the card, aside from the standard interest rate charged for the debt.
Not All Interest Is Equal
Credit card interest is where banks make the bulk of their profits. They charge interest, which compounds daily, increasing the interest you pay exponentially for every month you carry a balance. Not all interest is the same for all purchases rather it is based on how you use the credit card. The interest charged makes a significant impact on your long-term costs of borrowing the funds.
• Standard Rate includes most purchases you make with a credit card and is the rate quoted on the application. It is most often a variable rate that adjusts with the Prime Rate. The initial rate offered is based on your credit score at the time of application and remains at that level as long as you make on-time payments.
• Cash Advance rate applies to withdrawals from an ATM, or anytime you use your credit card as a debit card. Overdraft payments and other advances also charge the cash advance interest rate, in addition to transfer fees which can add another 3 to 5% to any withdrawal. A cash advance is the most expensive way to “borrow” money on your credit card. The rate can be several percentage points higher than the standard purchase rate.
• Promotional Rates give new cardholders an incentive to begin using the credit card immediately. Sometimes the offer includes zero percent on purchases and balance transfers for six months or more. Sometimes the offer is a very attractive single digit rate. Any purchases or transfers meeting the qualifications for the offer receive the low rate until the end of the promotion. Remaining balances at the end of the promotion revert to the higher purchase rate. SIMPLIFY
• Deferred Rates are popular among specialty retailers. You buy furniture, computers, or appliances at a zero percent rate for six months or more. The catch with deferred interest is that any balance not brought to zero by the end of the promotion voids the promotional rate for the entire purchase. To benefit from the zero percent, you must pay the balance in full by the promotions end.
Strategy to Get the Most of Credit Card Conveniences
The biggest benefit of a credit card is the convenience of putting purchases on a card and making a payment once a month instead of each day. You also gain the benefit of an interest-free loan if you pay the balance by the due date. Any remaining balance on the card will charge interest back to the purchase date. You also lose the interest-free grace period for new purchases when you carry a balance from month to month. Cash advances, on the other hand, never offer a grace period and begin charging interest immediately, even if you pay the full balance when due.
Managing credit cards is an art that can help even out cash flow and be a tool to manage money. However, when you succumb to the enticing of easy money, you wind up paying a very high price in the form of high interest and fees.
If you are burdened with high amounts of credit card debt and are struggling to make your payments, or you’re just not seeing your balances go down, call Timberline Financial today for a FREE financial analysis. Our team of highly skilled professionals will evaluate your current situation to see if you may qualify for one of our debt relief programs. You don’t have to struggle with high interest credit card debt any longer. Call (855) 250-8329 or get in touch with us by sending a message through our website.