Choosing a credit card: Read the fine print

Graham McCaulley, Extension Associate, MU Personal Financial Planning Extension

 

A credit card lets you buy things and pay for them over time. Using a credit card is like any borrowing — you have to pay the money back. 

 

Credit card features vary from card to card and there are several types of cards to choose from. To get the best deal, compare fees, charges, interest rates and benefits. Some credit cards that look like a great deal at first may really be a bad deal when you read the terms and conditions of use and see how the fees could affect your available credit.

 

Credit card terms

 

Important terms of use must be disclosed in any credit card application or for cards that don't require an application. Here are the terms to ask about when you consider credit offers. 
 

 

Many credit cards charge membership or participation fees. These fees have a variety of names, like "annual," "activation," "acceptance," "participation" and "monthly maintenance" fees. Fees may appear monthly, periodically or as one-time charges. They can have an immediate effect on your available credit.

 

In 2010, rules from the Credit Card Accountability Responsibility and Disclosure Act (Credit Card Act), as well as additional Federal Reserve regulations, went into effect to create new credit card consumer protections and disclosure requirements. These rules were further strengthened by the Dodd-Frank Wall Street Reform and Consumer Protection Act (Financial Reform Act). For example, these rules specify that fees, such as an annual fee or application fee, cannot total more than 25 percent of the initial credit limit.
 

 

Some credit cards add transaction fees and other charges if you use them to get a cash advance, if you make a late payment or if you go over your credit limit. The rule mentioned above regarding fees being less than 25 percent of the credit limit does not apply to these type of penalty fees.
 

 

Annual percentage rate (APR) is a measure of the cost of credit, expressed as a yearly rate. It must be disclosed before your account can be activated, and it must appear on your account statements.
 

 

The card issuer also must disclose the periodic rate. That's the rate the issuer applies to your balance to determine the finance charge for each billing period.
 

 

Some credit card plans let the issuer change the APR when interest rates or other economic indicators — called indexes — change. The rate change is linked to the index's performance and often varies. Rate changes can raise or lower the finance charge on your account. Before your account is activated, you must also be given information about any limits on how much and how often your rate may change.

 

If your card does not have a variable interest rate tied to an index, the credit card companies generally cannot raise your APR for the first 12 months after you open your account, and if the rate is going to be raised after that point, you should be given 45 days notice and the opportunity to cancel the card before the new rate takes effect.

 

A grace period, also called a "free period," lets you avoid finance charges if you pay your balance in full before the date it is due. Knowing whether a card gives you a grace period is important if you plan to pay your account in full each month.
 

 

Balance computation method is how the card issuers calculate your finance charge. If you don't have a grace period, it's important to know this. Which balance computation method is used can make a big difference in how much of a finance charge you pay — even if the APR and your buying patterns stay the same. 
 

 

Many credit card companies offer incentives for balance transfer offers — moving your debt from one credit card to another. All offers are not the same and the terms may be complicated. 
 

 

Many credit card issuers offer transfers with low introductory rates. Some issuers also charge balance transfer fees. In addition, if you pay late or fail to pay off your transferred balance before the introductory period ends, the issuer may raise the introductory rate and/or charge you interest retroactively. When you make payments, they are to be directed to highest interest balances first.

 

Balance computation methods

 

The average daily balance method credits your account from the day the issuer receives your payment. To figure the balance due, the issuer totals the beginning balance for each day in the billing period and subtracts any credits made that day. Although new purchases may or may not be added to the balance, cash advances typically are included. The resulting daily balances are added for the billing cycle. The total is divided by the number of days in the billing cycle to get the average daily balance. 
 

 

Adjusted balance is usually the most advantageous method for cardholders. The issuer determines your balance by subtracting payments or credits received during the current billing period from the balance at the end of the previous billing period. Purchases made during the billing period aren't included.
 

 

The previous balance is the amount owed at the end of the previous billing period. Payments, credits and purchases made during the current billing period are not included. Some creditors exclude unpaid finance charges. 
 

 

Credit card companies can only impose interest charges on balances in the current billing cycle (i.e., no two-cycle billing). If you don't understand how your balance is calculated, ask your card issuer. An explanation also must appear on your billing statements.

 

Other costs and features

 

Credit terms vary among issuers. When considering a credit card, think about how you plan to use it: 
 

        If you expect to pay your bills in full each month, the annual fee and other charges may be more important than the periodic rate and the APR.

        If you use the cash advance feature, pay attention to the APR and balance computation method.

        If you plan to pay for purchases over time, the APR and the balance computation method are major considerations.

 

You'll also want to consider if the credit limit is enough, how widely the card is accepted and the plan's services and features. 


 

Your credit card agreement explains what may happen if you default on your account. For example, if you are one day late with your payment, your issuer may be able to take certain actions, including raising the interest rate on your card. Some issuers' agreements even state that if you are in default on any financial account, those issuers' will consider you in default for them as well. This is known as universal default.
 

 

Some cards with low rates for on-time payments apply a very high APR if you are late a certain number of times in any specified time period. This is a type of special delinquency rate.

 

Help and information

 

Questions about a particular issuer should be sent to the agency with jurisdiction.

 

Office of the Comptroller of the Currency regulates banks with "national" in the name or "N.A." after the name:
Office of the Ombudsman
Customer Assistance Group
1301 McKinney Street,
Suite 3450
Houston, TX 77010
toll-free 800-613-6743 
www.occ.treas.gov

 

Board of Governors of the Federal Reserve System regulates state-chartered banks that are members of the Federal Reserve System, bank holding companies, and branches of foreign banks:
Federal Reserve Consumer Help
P.O. Box 1200
Minneapolis, MN 55480
toll-free 888-851-1920 
(TTY: 877-766-8533) 
ConsumerHelp@FederalReserve.gov

 

Federal Deposit Insurance Corporation regulates state-chartered banks that are not members of the Federal Reserve System:
Division of Supervision and Consumer Protection
550 17th Street, NW
Washington, DC 20429
toll-free 877-ASK-FDIC (275-3342)

www.fdic.gov

 

National Credit Union Administration regulates federally chartered credit unions:
Office of Public and Congressional Affairs
1775 Duke Street
Alexandria, VA 22314-3428
703-518-6330
www.ncua.gov

 

Office of Thrift Supervision regulates federal savings and loan associations and federal savings banks:
Consumer Programs
1700 G Street, NW
Washington, DC 20552
toll-free 800-842-6929
www.ots.treas.gov

 

Federal Trade Commission regulates non-bank lenders:
Consumer Response Center
600 Pennsylvania Avenue, NW
Washington, DC 20580
toll-free 877-FTC-HELP (382-4357)

www.ftc.gov

 

The FTC works for the consumer to prevent fraudulent, deceptive, and unfair business practices in the marketplace and to provide information to help consumers spot, stop, and avoid them. To file a complaint or to get free information on consumer issues, visit www.ftc.gov or call toll-free, 1-877-FTC-HELP (1-877-382-4357); TTY: 1-866-653-4261. The FTC enters consumer complaints into a secure online database and investigative tool used by hundreds of civil and criminal law enforcement agencies in the U.S. and abroad.

 

Source: Procter, B., & McCaulley, G. (2010). Choosing a credit card: Read the fine print (Research Brief). Columbia: University of Missouri, Human Environmental Sciences Extension.

http://missourifamilies.org/features/consumerarticles/choosecreditcard.htm 

 

Credit Report Basics

Do you ever wonder how lenders decide who gets a loan and who doesn't?  Ponder why you were turned down for that credit card? Think that you might file for bankruptcy and hope no one will ever know?  If so, you need to know more about your credit report, how it works, and how it can affect your financial future. The following information gives basic information about what a credit report is, who uses it, how to obtain a copy of your own, and correcting a mistake if you find one.

What is my credit report?

Your credit report is a compilation of financial data about you. Credit bureaus across the country compile credit information from banks, finance companies, merchants, credit card companies, and other creditors and enter it into a centralized computer system. Your report contains personal information such as your address, social security number, and birth date. It may also contain information about your employment and income, spouse’s information, former addresses, etc. More importantly, your credit report file details information about credit transactions and balances due, payment history, suits, judgments and tax liens. Your record also shows if you have declared bankruptcy. This is especially important to note, because this information will not be removed from your file for seven to ten years!

Who uses my credit report?

A potential creditor will usually check your credit report when you apply for a loan or credit card or rent an apartment. The lender or company will request a copy of your report and make their lending decision after reviewing your history. The lending company, not the credit bureau, makes the decision about whether you are approved or not. Although the credit reporting industry claims they do not sell credit scores to employers, there is nothing in the law to prohibit employers from obtaining a credit score if you give them written permission.  There are no reliable sources of information with respect to how often potential employees are asked to grant permission. Your report cannot be used by just anyone who wants information about you (such as friends). Anyone requesting a copy of your report must want it for an approved purpose and must be able to provide proof that they are a legitimate company with the right to view your report.

Can I see a copy of my credit report?

Yes, and in fact, it is a good idea to periodically check your credit reports to be sure that the information is correct. Congress created the 1971 Fair Credit Reporting Act, which gives you the right to see a copy of your re- port. As of March 1, 2005, you can order a free credit re- port one time each year. The three largest credit reporting bureaus are using one central address to provide this information. Do not contact the credit bureaus directly to obtain your free annual credit report.

 

To order your free credit report:

 

·         Visit www.annualcreditreport.com;

·         Call 1-877-322-8228; OR

·         Print the form at http://www.ftc.gov/bcp/conline/edcams/credit/ docs/fact_act_request_form.pdf and mail it to:        Annual Credit Report Request Service

PO Box 105281

Atlanta, GA 30348-5281

 

Be cautious about companies offering “free credit reports” on slick TV commercials, on websites or in magazine advertisements. Many of them have a snag such as having to pay a hidden fee for some other service they offer or requiring a subscription of some kind. You do not need a company to obtain a free

credit report for you; can you do it yourself. The contact information listed directly above is the official place to go to get your free credit report.

You can contact the three large credit reporting bureaus directly to request a free credit report every twelve months if:

·         you have been turned down for credit, employment or insurance within the last thirty days due to something in your credit report;

·         you are unemployed and plan to seek employment within 60 days;

·         you are on welfare; or

·         your report is inaccurate due to fraud. Otherwise, you usually have to pay a small fee to obtain

a copy of your report.

 

The three largest credit bureaus are:

•             Equifax

P.O. Box 740241

Atlanta, GA 30374

1-800-685-1111

 

•             Trans Union

2 Baldwin Place, P.O. Box 2000

Chester, PA 19022

1-800-888-4213

 

•             Experian

P.O. Box 2002

Allen, TX 75013

1-888-397-3742

 

There is also another large credit bureau called Innovis Data Solutions. This bureau differs from the other three main ones, however, because it sells your credit information to companies that compile mailings for unsolicited mail, including credit cards. You can also look under “Credit Bureaus” in your local yellow pages.

There is a mistake on my credit report. Now what? If you find an error on your credit report, contact the credit bureau. If the information is very old (more than seven to ten years), you should ask to have the information deleted. If it is a more recent error, provide as much information as you can about the situation. The bureau must investigate the problem. You also may try contacting the reporting party to see if they can help you resolve the situation. If you cannot resolve the issue, you can file a written statement of up to 100 words with the credit bureau telling your side of the story.

Note:

Beware of “credit repair” scams that promise to erase your bad credit history. You can take the same steps they will take to remove incorrect information without having to pay a high fee. Information that is legitimate, however, cannot be magically erased--by anyone!

 

Time Inconsistency: Today's Actions = Tomorrow's Regrets

Each month the Federal Reserve Bank of St. Louis publishes a newsletter titled Liber8, which is a selection of useful economic information, articles, data, and websites compiled by the librarians of the Federal Reserve Bank of St. Louis Research Library. This month the article is about Time Inconsistency and I thought that it brought up some interesting points, and some points that could be very debatable (particularly the author’s statement about a Federal balanced-budget rule). We encourage your comments and thoughts at http://mufinancialtip.blogspot.com.

 

There is a classroom version of Liber8 available for teachers for free at: http://liber8.stlouisfed.org/newsletter/2011/201109_ClassroomEdition.pdf

 

To subscribe to their newsletter or for more information and resources, visit their website and archives at http://liber8.stlouisfed.org.

 

The views expressed are those of the author and do not necessarily reflect the official positions of the Federal Reserve Bank of St. Louis, the Federal Reserve System, the Board of Governors, the University of Missouri, the Personal Financial Planning Department or The Office for Financial Success.

 

“A budget tells us what we can’t afford, but it doesn’t keep us from buying it.”

—William Feather

 

Have you ever bought something you really couldn’t afford? You simply swipe your credit card and leave the store with something shiny and new. That instant gratification overpowers any thought of the regret you’ll have when you must start paying off your accumulated debt. Economists call this phenomenon time inconsistency. An individual with time-inconsistent preferences pursues happiness today even if it results in unhappiness tomorrow. Consequently, he will make decisions that do not maximize lifetime satisfaction (i.e., utility).(1) In “econ speak,” a person with time-inconsistent preferences values the present more than the future. Accordingly, he will make decisions with a present bias, choosing what makes him happy in the moment. Thus, time inconsistency can be understood as the inability to consistently follow a good plan over one’s lifetime.

 

Let’s return to the shopping example. Even though you know that in the long-run you will have to work more hours and/or sacrifice other fun activities to pay your credit card bill (and the act of paying off that debt does not make you happy), showing off your new purchase maximizes your utility today.

 

Although this example describes time inconsistency using microeconomics, this concept also applies to macroeconomics. For example, just this summer, the government debated whether to raise the debt ceiling (the legal maximum amount the federal government can borrow) and how to implement policies to reduce future budget deficits. Ultimately, Congress voted to raise the debt ceiling without immediately reducing the deficit. This plan implies the government will neither have to cut spending on current programs nor raise taxes in the short run. The new law is most beneficial to policymakers today: They can continue to provide for their constituents just as before, thereby increasing their chances of re-election. In the long run, however, taxpayers will still have to repay the debt.(2) Thus, raising the debt ceiling will likely make politicians unhappy in the long run because of the political risks associated with increasing taxes and/or cutting government programs.

 

On the other hand, if Congress had voted to maintain the debt ceiling and reduce the budget deficit, the government would have had to cut current spending, raise taxes, or some combination of the two. Doing so would have made most politicians unhappy in the short run because cutting programs and/or raising taxes could risk their re-election and possibly hinder economic growth. In the long run, maintaining the debt ceiling could have resulted in more sustainable budgeting choices and programs in the future.

 

So how can individuals and governments maximize lifetime utility in the face of time inconsistency? Rather than making decisions with discretion—that is, selecting a course of action once a situation occurs— economists propose enacting credible rules—that is, mandating a predefined action/plan for a given situation. For our shopping example, a cash-only rule or a credit card with a lower spending limit may have prevented a splurge. In the case of the debt ceiling, a balanced-budget rule (as many state governments have) may have prevented the debt ceiling crisis. Using credible rules (e.g., enforcing a strict personal spending limit or a federal debt ceiling that cannot be raised) forces people to commit to certain actions. As a result, they will act in a more time-consistent manner: Their decisions today will take into account their future happiness.

 

—By E. Katarina Vermann, Research Analyst

 

(1)In contrast, a person with time-consistent preferences chooses what makes him happy today and tomorrow. These choices maximize lifetime utility (satisfaction).

 

(2) The government always has the option of defaulting on its future debt by monetizing the deficit (printing more money) and generating higher inflation. This option would also be suboptimal.

 

Articles on Time Inconsistency

“Like There’s No Tomorrow: How Economists Think About Procrastination,” by Ray Fisman. SLATE, Thursday, May 15, 2008. http://www.slate.com/id/2191140/

This article discusses specific ways to overcome procrastination (a time-inconsistent behavior).

 

“Time Inconsistency,” by Greg Mankiw. Random Observations for Students of Economics (blog), Wednesday, April 19, 2006. http://gregmankiw.blogspot.com/2006/04/time-inconsistency.html

This blog post discusses the time inconsistency of government policy and the need for fixed policy rules.

 

“Rules vs. Discretion: The Wrong Choice Could Open the Floodgates,” by Jason Buol and Mark Vaughan. Federal Reserve Bank of St. Louis Regional Economist, January 2003. http://stlouisfed.org/publications/re/articles/?id=426

This article discusses (i) how discretionary policy can lead people to make poor choices in expectation of a government bailout and (ii) the need for policy rules to enable the outcome demanded by the public in the short run to be consistent with that desired in the long run.

 

Free Resources

Resource: “Political Negotiations Also Shaped by Human Psychology,” by Shankar Vedantam. Morning Edition news story (audio), July 28, 2011

Description: A psychological look at the debt-ceiling debate.

Published by: National Public Radio, The Two-Way, NPR’s News Blog

Location: www.npr.org/blogs/thetwo-way/2011/07/29/138802290/political-negotiations-also-shaped-byhuman-psychology

 

Resource: Budget Hero

Description: An interactive game that allows the user to decide use of tax dollars based on the budget model and forecasts in the Congressional Budget Office “CBO’s 2011 Long-Term Budget Outlook.”

Published by: American Public Media, Minnesota Public Radio

Location: http://minnesota.publicradio.org/projects/2008/05/budget_hero/

 

Resource: “Q. & A. on the Debt Ceiling,” by Michael Cooper and Louise Story, New York Times, July 27, 2011

Description: Explains the implications of the debt ceiling and includes explanatory charts and the video “The History of the Debt Limit.”

Published by: New York Times

Location: www.nytimes.com/2011/07/28/us/politics/28default.html?ref=nationaldebtus

 

Ryan H. Law, M.S., AFC

 

Personal Financial Planning Department

Office for Financial Success Director

University of Missouri Center on Economic Education Director

 

239E Stanley Hall

University of Missouri

Columbia, MO 65211

 

573.882.9211 (office)

573.884.8389 (fax)

A Strategy for Getting Out of Debt

Ryan H. Law, AFC

In response to the Credit Card Act of 2009 (most of which went into effect February 22) credit card issuers have raised rates, raised minimum payments, lowered credit limits and added on extra fees.  Here are some statistics:

·         53% of 2000 people surveyed reported an increase in their credit card interest rate in the past year.  One card jacked its rate up to 79.9%.  That’s not a typo – 79.9%!

·         26% reported reduced credit limits

·         21% reported increased fees

Source: Credit Card Tricks and Traps http://www.rd.com/advice-and-know-how/credit-card-tricks-and-traps/article175291.html

Note:  To learn more about the Credit Card Act of 2009 please see Dr. Rob Weagley’s article here: http://mufinancialtip.blogspot.com/search?q=credit+card+act.

So do you just have to put up with this from your credit card issuers?  Of course not!

If you are finished paying too much of your hard earned money to interest and fees then it’s time for you to develop a debt elimination plan.  Here’s what you need to do:

1.      Make a commitment to STOP charging things to your credit cards.  Cut the cards up, shred them or do whatever you need to do to stop using your cards.

2.      Build up an emergency fund.  If you use your credit card for emergencies you can avoid doing that in the future by building up an emergency fund.  Experts recommend you have 3-6 months of expenses saved up.  Make that your long-term goal.  For the time being, though, try to get one full paycheck in the bank as soon as possible.

3.      Gather up all of your recent statements and make a list that has the creditor name, amount owed, minimum payment and interest rate.  For our example let’s use the following numbers:

Creditor Name	Amount Owed	Minimum Payment	Interest Rate
Citicard	$14,567	$230	18%
Discover	$994	$60	12%
Visa	$7729	$262	29%
Student Loans	$19,334	$223	6.8%
Auto Loan	$21,000	$406	6%

 

4.      Pay the minimum on each card and any extra towards your highest interest loan.  A common mistake people make if they have an extra $50 is to put $20 on this card, $10 on another, etc.  If you concentrate any extra money on one debt, though, you will get it paid off much faster.

5.      Make Power Payments.  When you have paid off your first debt, roll that amount over to start paying on your next highest interest rate debt.  It would look like this:

Visa	Citicard	Discover	Student Loan	Auto Loan
$262	$230	$60	$223	$406
$262	$230	$60	$223	$406
-	$492	$60	$223	$406
-	$492	$60	$223	$406
-	-	$552	$223	$406
-	-	-	$775	$406

 

Can you see how powerful this technique is?  Using this technique can save you thousands of dollars in interest and shave years off your repayment time.

There is software available that will help you set this up and give you detailed payment calendars.  It was developed by Utah State University Extension and is available online, for free.  The software is called Power Pay and you can access it at http://www.powerpay.org. 

I plugged the numbers above into the software and here are the results:

Paying the debts off without power payments will take you 16 years, 10 months to pay off.  The total you will pay back is $112,104.09, with $48,480.09 being interest!

If you pay using power payments, though, it will take you 6 years, 5 months to pay off with a total payoff of $90,891.04 ($27,267.04 being interest).

Power payments save you 10 years and 5 months and $21,213.05 in interest!

There is also a feature on Power Pay where you can add extra payments, so if you are getting a tax refund you can plug that in there, or if you can devote an extra $100 to debt you can plug that in there.

I encourage you to take some time to plug your own information in the software to see how power payments will benefit you.  If you are a teacher I encourage you to use this software for an in-class demonstration and assignment.  Make some numbers up then ask your students to plug them in and come up with the answers to a series of questions (i.e. how much will the payment be to Visa in September of 2011?).