Credit Card Costs

You have probably seen ads promising free credit cards or enountered search results offering free credit cards during your research to find the best card for you. Credit cards can be one of the most expensive types of consumer loans available today or one of the least expensive but they are rarely free. Fairly priced cards are available, but they're sometimes harder to find (and get) and if you don't read the fine print, you could pay more than you thought you would.

Credit cards have costs, even those offered as free credit cards.  It used to be that credit card companies wouldn't even tell you how about credit card costs until you actually got the card in your hands. Congress put a halt to that, however, by passing the Fair Credit and Charge Card Disclosure Act of 1989. Card issuers now, by law, have to give you details up front about how much a credit card costs. Under this law, which is part of the Truth-in-Lending Act, the costs of credit cards must be displayed in an easy-to-read box format on most applications and solicitations. The box that lists the costs of the card is dubbed the "Schumer Box," after Senator Charles Schumer (D-NY), who led this consumer-protection legislation through Congress.

There are five basic elements to look at when you're selecting a credit card: finance charges, annual fees, grace periods, penalty fees, and balance calculation methods.  In this article we will explain finance charges, annual fees, grace periods, and penalty fees and how they affect the cost of the credit you use.  You'll see that even free credit cards have costs.   We'll cover Balance Calculation Methods in a separate article.  

Finance Charges

A finance charge (also called "interest") is the "commission" you pay the bank for lending you money. Most people don't pay their credit card bills off each month in fact, somewhere between one-third and one-half do. If you do pay in full, you'll usually, but not always, be charged no interest at all. Those who fail to pay off all their credit cards in full at the end of every month pay interest (or finance charges).

You will see finance charges listed on your credit card statement in two ways: as a "monthly periodic rate" and as an "APR." APR stands for "annual percentage rate," and it simply means the stated amount of interest you will pay on a yearly basis. An APR of 19.8 percent means you will pay 19.8 percent interest over the course of a year on your balances. Divide that 19.8 percent APR by 12 (months), and you have a monthly periodic rate of 1.65 percent.

Even worse, the stated finance charge the card issuer charges is often lower than the actual amount of interest you will pay on the card, because of the way interest is calculated on credit cards.

Annual Fees

Free Credit Cards: An article in the December 18, 1980, issue of the New York Times announced that Citibank was going to begin charging cardholders a $15 annual fee. In those days, many bankcards did not charge annual fees. American Express, Diner's Club, and Carte Blanche cost $35 back then.

Annual fees (or "membership fees," as they are sometimes called) now range anywhere from $0 to $100 or more, while the average is about $20. These fees can add up. Suppose you have three bankcards, each charging $25 apiece that's $75 a year. There are, however, cards that carry no annual fees. A free credit card isn't a giveaway for the issuer. Most cardholders pay interest, and that's where issuers really make money. In addition, every time you use your card, the merchant pays a percentage of the purchase (called a "merchant discount fee") to the card companies for the privilege of accepting the card. A small portion of the merchant discount fee, which typically ranges from 1.5 to 4 percent of the purchase amount, is passed on to the card issuer.

If your credit card carries an annual fee, your card issuer must warn you thirty days before the card will be renewed, so you will have the opportunity to cancel the card before you pay the fee. This notice will appear on your billing statement; it must disclose how much the annual fee will cost and tell you how and when to close your account if you don't want to pay the annual fee.

Grace Periods

A Free Ride? A grace period, or "free-ride" period, is the time between the closing date of the billing cycle and the due date that you have to pay the balance in full and be charged no finance charge. If it sounds really confusing, that's because it is.
If your card has a grace period, the bill will usually read "Pay this amount to avoid further finance charges ..." next to the total balance. If your card does not have a grace period, you can pay off your bill in full at the end of the month, and you will find next month that you were charged interest anyway.

People are usually confused about how grace periods really work, and I don't blame them. The way interest is calculated on credit cards is very complicated. Just remember this: You usually get the benefit of a grace period only if you pay the entire bill in full by the due date.

You should understand that unless you pay off every last penny at the end of the month, the grace period is useless.

Some credit cards do not offer a grace period. That doesn't necessarily make the card a bad deal. Some people can actually save more money with a card that offers no grace period than one that does.

Penalty Fees

Late fees, over-the-limit fees, transaction fees, and bounced-check fees on credit cards were uncommon, if not unknown, in the mid-1980s. But as soon as a few large banks wised up to the fact that they could charge additional fees to cardholders who didn't pay their accounts as agreed, penalty fees became almost commonplace. These days, most issuers charge penalty fees, although you may find a few issuers that don't.
Penalty fees can be very expensive, and in few cases do they actually reflect the bank's cost of processing the transaction. Besides, that is what interest is for: to cover the bank's costs and make a reasonable profit. Even worse, some banks will add the fee to your current balance and charge you interest on the fee as well as the balance!
Wells Fargo Bank, one of the largest card issuers in the country, in 1991 settled a class-action suit over its over-the-limit fees. The verdict? It could not charge over-the-limit fees for the next four years, a loss of probably $1 million in fees it could have collected. Wells Fargo was also sued because of late fees. In a separate story reported in the February 16, 1989, issue of The Wall Street Journal, a California state court jury determined that Wells Fargo had illegally overcharged its credit card holders with its late fees of $10 and over-limit fees of $3 to $5. The total overcharge: $5.2 million.

Here's what to look out for in penalty fees:

Cash Advance Fees: Card issuers already can make a tidy sum off cash advances, since they usually charge interest from the day you take out the cash advance (regardless of whether you pay the balance in full at the end of the month). Often they make even more by charging higher interest rates on cash advances than on purchases. On top of that, most issuers add on a cash advance fee-as much as 2 to 4 percent of the amount of the cash advance (sometimes capped at $25 to $50)-simply for the privilege of borrowing cash instead of making a purchase. Be sure to check with your bank before you take out a cash advance to find out what kinds of fees they charge.

A few issuers have advertised in the past that they charge a fee instead of interest right away, but don't assume that makes them a better deal. The banks that pulled that trick in the past charged more for the fee than it would have cost for one month's interest at their already high interest rates! And even those banks that do offer a "grace period" on cash advances will start charging interest if you can't pay the advance off in full by the due date.

Late Fees: Some banks charge a fee of $10 to $35 if you fail to pay your bill on time. Most issuers used to wait until you were a full month behind before charging a late fee. Then some started charging if you fell behind by fifteen days. Now most will impose a late fee if you are just one day late with a payment. In addition, many cardholder agreements specify a time (say 11 a.m.) by which payments must be received on the due date in order to be considered on time. Your interest rate may also skyrocket if you are late with your payments.

Over-the-Limit Fees: Card issuers shouldn't get away with charging an over-limit fee of $10 to $35, but they do. After all, if you are over your limit, you are either carrying a high balance (which likely means you are a profitable account for the bank, since you pay a lot of interest), or you charged a lot during the month (which also makes you a profitable account, since you generated income in merchant discount fees).

If you go over the limit, your card issuer is likely to send you a notice asking you to pay the over-limit amount in full immediately. Regardless, you'll pay interest on the over-limit amount and may pay a penalty fee as well. Sometimes they'll charge an over-limit fee every single month until you are able to bring the balance down under the limit.

Transaction Fees: These are particularly onerous because most consumers don't know about them until it is too late. A transaction fee is a fee that is charged each time you use the card. A typical transaction fee from a card issuer that charges one would be fifty cents per charge. Fortunately, most issuers don't charge transaction fees, but if you find one that does, you're probably smart to just say "no" to the offer.

If you see this language on a credit card disclosure statement: "A minimum finance charge of fifty cents will be charged in any month during which a periodic finance charge is payable," don't confuse it with a transaction charge. This simply means that if your finance charge for the month is between one cent and forty-nine cents, it will be rounded off to fifty cents on your bill.