Wednesday, February 3, 2010

Understanding Credit Cards


I often tell young people that they should treat a credit card like a major asset - like a car or an expensive appliance. Thus puzzles them, as they view a credit card as merely a cheap piece of plastic.

But if you think about it, a credit card can easily have a credit limit (or worse yet, a balance) of $10,000, $20,000 or even (much) more. One could easily buy a new Mercedes with the amount of credit available on some credit cards. They are a very powerful and dangerous thing.
Actually, a credit card can be a lot like a loaded handgun. You can hurt yourself quite easily with it. Credit card companies are not your friends, any more than the local loan sharks are. It is very easy to get deep into credit card debt and not be able to dig your way out. That's the way the deal is structured. Buyer beware!

Credit Cards are, to some extent, necessary in this day and age. You can't rent a car without one, and they certainly come in handy in emergencies. If you are self-employed like me, a credit card can be necessary to tide one over between paydays. And if you run a business, you need one to pay for goods and services, and it can make running a business so much easier.

But many people fall into the credit card debt trap. I have, so I know firsthand how it works. It is easy to do. Like television, Credit Cards are fatally attractive to those with addictive personalities. If you read blogs relating to credit card debt and problems, you often hear people refer to credit cards in the same way junkies refer to their drugs. Shiny plastic cards are probably one of the strongest drugs out there, and they can ruin lives and marriages.

With the Republican sponsored "Bankruptcy Reform Act" passed a few years back, it is harder and harder to get out from underneath credit card debt by declaring bankruptcy. Credit Card companies loved it when their customers spent up to the limit, and paid off in only small increments. But they hated it when those same customers walked away from huge bills by going Chapter 7 on them. So they made that harder to do. As a result, getting caught in the credit trap can really hurt you in a big way.

Here are some small things I've learned:

1. Get the lowest interest rate and keep it: Getting cards with airline miles on them, or ones that sponsor your favorite college or organization are neat and all, but these often carry the highest interest rates. Why? Simple. Those "Free Frequent Flier Miles" are not free, but are paid for by the card companies to the airlines. So they jack up the rates to cover their costs. While it is a nice fantasy to say "Well, I'll pay off the balance every month and never pay interest" the reality is that if you don't pay the balance off for even ONE month, huge credit charges apply. Suppose you have an emergency and need to charge more than you can pay off in a month? You are then stuck with high interest charges. I have a "Frequent Flier" card that I do pay off every month. That has an interest rate of 18%. My other "low interest" card with no benefits, has a rate of 6.7% Which one is the real bargain? Owning a high interest card can be a dangerous temptation. If a balance builds up, it can be much harder to pay off.
And when getting a low rate, remember that some low rates are basically "teaser" rates that expire after a year or so, or go to astronomical rates (21.9% or higher) if you are even one day late with a payment. Yes, yes, you always pay your bills on time, right? So you have no worries, right? WRONG! If a statement or payment is lost in the mail, tough! If you mail it too late, tough! If you forget to pay online, tough! If you setup automatic payments and the bank messes up, tough! Jacking up rates for even one late payment make credit cards like a loaded handgun ready to go off.
And in today's world, banks have no incentive to lower rates anymore. Credit is tight, and they realize you will not likely "take your business elsewhere", particularly if you are near your credit limit. Those neat credit card offers tend to dry up once you are even a day late on a payment.
So when looking for a low rate, pick a rate that is low and STAYS low. Ask if the low rate expires or can be "adjusted" at whim, or will go up with late payments or any other indicia. Some credit card companies word the agreements to allow them to raise their rates based on your credit score. If you get into trouble, then you are in deep trouble.

2. Setup Autopay for the Minimum Monthly Payment: Not paying off the balance every month is bad. Not making any payment at all is horrific. And it can happen to anyone. I pay my bills online and once, before leaving for vacation, I made a payment on my card. When I got back from vacation, I was appalled to find that the interest rate had skyrocketed. When I called to find out why, they told me I had paid one day earlier than scheduled, so that my monthly payment for the next month was "missing." It can happen to anyone - if they lose a payment in the mail for example. And if you read the fine print, most cards will jack your interest rate to 22% or even as high as 36% (!!) if you are late on even one payment. In this instance, I was covered, though, as the card company agreed to credit my account for the proper month, waive the late fee, and reinstate my previous interest rate. I setup both cards (personal and business) to deduct the minimum payment every month from my checking account. That way, if I forget to pay the card or don' t pay it on time, at least I am not socked with a late fee AND the staggering higher interest rate.

3. Check your balance weekly or more: Waiting for the end of the month for the mailed statement is a very bad idea. To begin with, statements can get lost in the mail (and you may then forget to send payment). Moreover, you may find that your balance is unexpectedly high at the end of the month, and your well laid plans of "paying off the balance every month" go awry very quickly. The good news is, nearly every credit card company now has a website you can log into to check your balance and even make payments. By logging in frequently, you can check to see how much you are spending, and also make yourself more aware of what your balance at the end of the month will be. No "surprises" at the end of the month.

4. Know Your Card Stats: It is funny how some folks will know how many horsepower their car has, how fast it can go from 0 to 60 and what the mileage was when they last changed the oil, but they have no idea what their interest rate is, the statement date, and payment due date for their card is. Like I said, a credit card is as expensive, powerful, dangerous, and necessary as an automobile. Being ignorant of either can be costly. You should know what date your statement closes, when your payments are due, and what your interest rate(s) are.

5. Use the Cramdown: And don't be afraid to "cram down" your card provider on fees and interest rate. If you tell the card provider you plan on switching cards, they will usually waive fees and lower interest rates. To make this threat credible, however, you have to have a low or zero balance and a good credit rating. If you have a high balance and bad credit, well, they know you aren't going anywhere anytime soon and they will tell you what interest rate you are paying.

I went to cancel one high-interest rate card once, and was transferred to a "cancellation specialist." I listened to their spiel and then calmly told them the reason I was cancelling the card - I could get a lower rate elsewhere with no fees. After a short pause, the representative put me on hold and then came back with yet a lower rate than the competing card. If you don't need the money, they are more than willing to loan it to you, as the old saying goes.
Cramdown tactics are not available to those who have high balances, though. If your card is paid off every month, they will offer a lower rate. If you have a high balance, they know you are "stuck" with the debt, and they will try to foist the highest rates possible on you.

6. Pay cash: As I noted in my previous blog post, carrying and paying cash is a good idea. As a youth, I did not carry cash as I felt I would be tempted to spend it, and also I was worried I would get "robbed". Both fears turned out to be wrongly founded. By not carrying cash, I just ended up spending money on credit cards or bouncing checks. And I haven't been robbed in my lifetime. Paying cash has other advantages. Many small businesses prefer cash, as they don't have to pay high credit card charge fees. In addition, they may (ahem!) keep the transaction off the books. So you make friends when you pay cash.

7. Cutoff Card Spending: If you find yourself with an alarming and growing balance on your credit card, don't panic. The first thing to do is STOP USING THE CARD, PERIOD. Revolving credit is just what it means; it keeps revolving and revolving so long as there is a balance on that card. The only way to put an end to those interest payments is to stop using the card and pay off the balance. If you keep adding incremental charges to the card and keep it near its limit, you will never pay it off, and you will end up spending hundreds, if not thousands of dollars per year in interest charges.

8. Use Balance Transfers Wisely and Carefully: We've all gotten those offers in the mail - little checks you can just cut out and spend, right? Well, think carefully before doing a balance transfer or getting a cash advance. Both can be dangerous to your financial health if used foolishly. To begin with, one fatal mistake many folks make is to use a balance transfer offer to "pay off" an old, high interest rate credit card, and then run up new debt on that very same old card. Now they have twice as much debt as before, with no end in sight. Once the initial "teaser" rate on the balance transfer disappears, the consumer now has twice as much high-interest revolving credit.

These balance transfer offers CAN be helpful in some circumstances. If you CUT UP your old card and transfer the balance to another card at a lower rate, it can give you the "breathing room" to start paying back that debt. With rates as low as 4.99% or even 0%, you can cut a monthly interest charge of $250 or more in half or even to zero. So long as you take that savings and use it to PAY DOWN the debt, you can come out ahead. However, the card companies are counting on you spending that money on new useless gadgets, toys, restaurant meals, and other junk and hoping you'll end up as another debt slave.

For my situation, I needed some cash to pay my tax bill. I could just go online to one of those tax payment services, which for a 2-5% fee of the total, would process my credit card to pay the tax bill. 2-5% is a lot of money. Ouch. On top of that, I would have to pay the regular purchase rate on the debt on the card, which could be as high as 17%. Double ouch. However, the friendly card company would process a cash advance at 4.99% for 12 months over the phone while waiving the 2% service fee. Nice. That's cheaper money than my credit union will loan.

There are catches, though. The interest rate rockets upward if you are even one payment late. And if ANY of that debt is still on the balance 12 months later, the rate goes up to the regular purchase rate. Needless to say, I'm making this a VERY short-term loan! So long as you strictly play by their rules, these deals can be good - but there is little or no room for error.

NOTE: Credit Card Companies are NOT STUPID. One trick they can use is to change the terms on your card. How does this work? They send you a letter saying "we are changing your interest rate to 15% next month. If you don't agree to this, you can still have your old rate, but they will close the account once the card expires. Citibank has done this recently to over 4,000,000 (FOUR MILLION) customers. Of course, they are loathe to lose customers, so before the card expires they will gladly talk about renewing the card at a higher rate.

9. Cut Your Credit Limit: You've gotten letters in the mail from your credit card company that goes something like this: "Congratulations! We've raised your credit limit!" Gee, thanks. More debt I can get into! One way not to spend money is not to have it. One way not to get into debt is not to have a tempting line-of-credit to fall into. Call your credit card company and ask them to lower your limit to an amount you feel comfortable with. There is nothing wrong with this, provided you don't charge over the limit and incur over-limit fees. Again, frequently checking your balance and using CASH instead of credit can prevent this from happening.

10. Debit Cards: Credit Card companies like to tell horror stories about debit cards. "If someone STEALS YOUR IDENTITY they could DRAIN YOUR BANK ACCOUNT" they say. There are certain precautions you need to take with debit cards, of course, but they can be very safe to use. To begin with, the "Identity Theft" thing is totally over-hyped (like terrorism) by folks with an agenda (usually selling something, like credit protector, or a missile system). Checking the balance on your bank account and reconciling it DAILY (or nearly so) is the best way to avoid problems. When paying with your Debit card ask the clerk to "run it as a credit" (with a signature, not a PIN). This may provide you with additional credit-card like protections, and also prevents anyone from learning your PIN. If you use a Debit card responsibly, you can avoid carrying a balance and also avoid interest rates and charges.

It might be a good idea to tie your debit card to a working account that doesn't have a large balance (like your life savings) so it can't be drained if someone hacks into it. But make sure the balance is enough to more than pay your bills. For example, when I was younger, I wrote a check from my account to pay the rent. There was $50 left over in the account (I was poor), so I went out for Chinese food that night. The clerk kept swiping the card several times and for some reason the charge did not go through. After his fourth attempt, the charge went through and I though everything was OK.

The next day, I checked the balance on my account (I was anal-retentive even then) and was horrified to discover FOUR charges for Chinese food on my account. What's more, my landlord had tried to cash my rent check - and because of the erroneous Chinese food charges, it BOUNCED.

Ouch. What happens when Merchants "authorize and settle" a credit or debit card is that often a hold is first placed on the card ("authorize") and then when the transaction is completed, the amount is settled. Once the Chinese restaurant ran a settlement later the next day, the erroneous charges came off my account. But the fact remained that the three erroneous "holds" on the account meant my balance was too low to clear the rent check.

The moral is to never spend your account down that low - with a DEBIT card. If you have to squeak the last penny out of your bank account, write a check (which the Chinese place would have taken) or pay cash.

11. Paying Off Credit Card Debt by Refinancing Your Home: Everyone has probably done this once, and it is a very bad idea unless you really, really are in serious financial trouble and are willing to use this as a start of a turnaround, and not just another "fix" for the credit card junky. The temptation was simple: Back before the Real Estate Crash, housing values shot up and interest rates were dropping. You could refinance your house and "take out" enough money to pay off your credit cards (or more) and still have nearly the same monthly payment, or maybe just a little more.

On paper, it sounds like a swell idea - to folks who look at money as monthly increments and monthly payments only. Your monthly cash flow will improve greatly, and now you have a paid off credit card! The problems are multiple: To begin with, you now have more debt on your home, which may or may not be tax deductible (Uncle Sam has not checked up on this, but it is supposed to be limited to loans up to PURCHASE PRICE only!). Your major asset is now further encumbered. That debt will have to be paid off someday - and all that restaurant food you charged on your credit card is now financed over 30 years. The second problem is obvious: Once you've paid off the credit card, the credit card junky in you will temp you to rack the balance right back up again. Double Ouch. Third, when making these transactions take place, those friendly and helpful mortgage brokers and closing agents are all too happy to slap on all sorts of "junk fees" and the like, which add to the balance of your mortgage. You end up spending just as much, if not more, than you would have if you had paid off the card the regular way. You just don't realize it because they've spread all the fees out over 30 years.

The major problem with this, of course, is that it has lead to the credit and Real Estate "crises" we are in now. Many folks mortgaged their homes to 100% of market value - some even to 110% or more. Weird loans were available back then. Now that prices are falling, these folks are "upside down" in their homes, and if they want to sell, they'd have to just walk away or declare bankruptcy. And of course, many of these "re-fi" loans were toxic ARMS or other "novel" instruments such as balloon notes or payment optional notes that now have indexed up and locked their borrowers into unaffordable payments.

If you really, really are over a barrel, refinancing can be helpful. But going in, you should search for the best FIXED RATE loan possible with no points or junk fees. Come-on artists and mortgage places that advertise heavily usually try to sneak this stuff into the agreement. Just avoid them entirely. And you should have a debt PLAN in place to make sure you are not refinancing four years later with yet another "maxed out" credit card.

Of course, all that advice is probably moot. Few lenders are making refinancing loans these days. It's hard enough to get a 30-year fixed with 20% down.

But maybe that's the way it should be....
* * * * * * *
Credit Card companies are kings of the fine print. And the way they treat their customers often forces them in to bankruptcy. They lure people into agreements with low rates and high credit limits, and then, if even one payment is a day late, raise the interest rate to the point where the borrower can never pay off the balance.
If you read my article on SCAMS, you'll see that the typical credit card company hits several of the scam indicia: They use Fine Print; Too-good-t0-be-true low initial rates; and the entire business relationship predicated on a lie.
If you can live without a credit card, you are far better off. If you feel you have to have one, treat it gingerly and carefully. It is all too easy to 'get in over your head' and end up in bankruptcy, as happened to at least one young friend of mine.

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