3 Credit Card Traps That Can Cost You a Bundle

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TV commercials for credit cards show happy people enjoying life. If only you applied for such a credit card, you too could be living the dream.

Don't be fooled. Your interests and the interests of your credit card company are not aligned. And I know: I used to run a profitable credit card business.

For the lender, an ideal customer is someone who maxes out their card and only pays the minimum due, one week late, every month. Consider this scenario: If a person borrows up to a credit limit of $10,000, has a 21 percent interest rate and makes only their minimum payments, that customer would pay more than $2,000 in interest alone over the next 12 months. If he paid late every month, he'd be out another $420 (in 12 $35 fees).

To help you avoid becoming an ideal customer, I'll explain the three ways credit cards make money, then unveil the typical tricks used by the banks, and give you tips so that you can make credit cards work for you.

1. Interchange

Every time you use your card, the merchant pays an interchange fee to your credit card company. Interchange rates average 2 percent. Last year, Americans spent $2.2 trillion on credit cards issued by the top 15 banks. If banks kept the 2 percent interchange, that would be $45 billion in their pockets, and not in yours. Your goal: Get it all back.

Whether you pay with a credit card, debit card or cash, your price is the same. But, if you use the right credit card, you can get cash back or airline miles. Think of it as a rebate, because it's your own money. But beware of advertised deals that look too good to be true: Banks only get 2 percent, so promising you more should raise suspicion. Typical tricks include:
  • Advertising a really high cash back rate. Discover (DFS) and Chase (JPM) do this, by advertising 5 percent cash back. But you only get 5 percent on certain categories that rotate every quarter and are capped. You have to opt in every quarter. All other categories pay only 1 percent.
  • Advertising a higher rate on fixed categories. Bank of America (BAC) offers 3 percent on gas, 2 percent on groceries and 1 percent on everything else. But the 3 percent and 2 percent are capped to $1,500 in spending per quarter.
  • Giving a massive introductory bonus. Wells Fargo (WFC) offers a credit card where you can earn 5 percent on gas, groceries and drugstores for the first six months. But then the cash-back rate drops to 1 percent.
  • Creating a rewards currency, but hiding its real value. When a bank creates its own currency (like Regions Bank Relationship Rewards (RF)), they tend to tell you how many points you will earn, but they're not so eager to tell you what the points are worth. Usually, it's less than 1 percent of the money you spent to get them.
If you want to be a gamer, then you could spend a lot time going from bonus offer to bonus offer. You could carry multiple cards and make sure you use the card that offers the best deal for that purchase at that time. But that is a lot of work.

Personally, I look for a card that offers a flat, no-gimmick, high cash back rate. Two of my favorites:
  • The Fidelity Investment Rewards American Express Card (AXP) pays 2 percent cash back on every transaction, with no cap. The only catch: you must have a Fidelity account, where your cash will be deposited. Why does Fidelity do this? It is not in the credit card business. Its goal is to grow your balance at Fidelity, and the cash back does just that.
  • Capital One Quicksilver (COF) offers 1.5 percent cash back on all of your spending, without caps.
If you are consistent in where and how you spend money, then higher-category cards (like Bank of America) may be a better option. But, you need to run the numbers. We have made that easy for you at MagnifyMoney, where you can input how much you spend (by category) and see how much cash back you could earn.

If you are a frequent flier, earning miles may make sense. With an airline card, the bank uses the interchange to buy miles from the airline, rather than giving you cash.

Frequent flier programs can be confusing, and you need a lot of miles to get free flights. To see how much free travel you can earn, a tool at MileCards asks you how much you spend each month and where you want to travel. The tool shows how many miles you earn, and the value of those miles. You can compare that to the cash back you would earn, and make an informed decision.

Make sure you pay the balance in full and on time every month. If the bank gives you 2 percent, it will try to make money elsewhere.

2. Interest

Charging interest on debt is the big money maker for credit card companies. Their goal is simple: get you to borrow as much as possible at an interest rate that is as high as possible.

To get you to borrow, credit card companies give big credit limits. Bankers refer to the maximum amount of debt you can handle as the tipping point, and they have statistical models to get you as close to the tipping point as possible.

Interest rates are high. I often see 15 percent quoted as the average rate. But banks charge different interest rates depending upon the customer profile. If you do not pay your balance in full every month, you are considered riskier. Riskier customers get higher rates. We did a national survey, and 75 percent of people with credit card debt paid higher than 15 percent.

Your interest rate can still be increased by your credit card company if:
  1. You engage in risky behavior, like missing a payment (even by a day) or going over your credit limit. Banks can increase your interest rate on all future transactions. Thanks to the CARD Act, they cannot increase the rate on your existing balance.
  2. You become 60 days late. Once that happens, you lose your CARD Act protections, and they can increase the interest rate on your existing balance as well.
So, what is the best strategy? Do not mix your spending with your borrowing, and always pay on time.

You should have a credit card for spending. On this credit card, you earn cash back and pay the balance in full every month. You will never pay any interest at all. If you don't have the self-discipline to only spend only what you can afford, don't be afraid to use cash.

For your debt, you should find the lowest interest rate credit card available, transfer the balance to that card and then hide that card in the freezer. In my last article, I showed how I saved a woman over $3,000 in 30 minutes.

Final warning: cash advances are the most expensive form of credit card borrowing. There is usually an up-front fee, and interest is charged immediately.

3. Fees

There are two types of fees: punishment and transaction.

Punishment fees include:
  • Late fees. Avoid by signing up for a direct debit. Otherwise, be aware of the cutoff times for payments, which are often as early as 5 p.m.
  • Over-the-credit-limit. Banks need your permission to charge this fee. Don't give it.
  • Returned payment or returned check. If you write a check that bounces, then you could be hit with both a returned payment and late fee.
Transaction fees include:
  • Cash advance fees. They average a steep 3 percent.
  • Foreign transaction fees. The fee averages 3 percent when you use your credit card abroad. Many cards now charge no foreign transaction fees, including all cards offered by Capital One. (With Capital One Quicksilver, you avoid the fee and earn cash back).
Some credit cards have annual fees. The tools I recommended take the annual fee into account when calculating the benefit you receive. Only pay the fee if you are confident in how much you are going to spend, and the reward you are going to receive.

More Money in Your Pocket

Credit cards are complex. But these four tips will put more money in your pocket:
  1. Have a spending card. Earn at least 1.5 percent, and pay off the balance in full, every month.
  2. If you have debt, find the lowest interest rate credit card (usually with a balance transfer). Move your debt to the lowest rate and put the card in the freezer.
  3. Make sure you always pay on time. Even paying a day late can be obscenely expensive (late fees and higher interest rates).
  4. If you travel overseas, make sure you take a card with no foreign transaction fee.
Nick Clements is the co-founder of MagnifyMoney.com, a website that makes it easy to cut your costs without cutting your lifestyle. He spent nearly 15 years in consumer banking, and most recently he ran the largest credit card business in the U.K.

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Denzil OConnell

Im a no credit card advocate especially if you can't handle the spending urge either on or offline ...The card or cards just take your peace of mind away leading to more stress read my blog on dealing with credit cards below


July 12 2014 at 5:01 AM Report abuse rate up rate down Reply
Jeremy Ochsner

Good information, I had one question: Not sure about the average interchange fees that are being quoted at 2%. This may be something of a general rule of thumb, verses reality for an American business owners fees for credit card processing? Could also be the difference between a UK merchant account and a US merchant account?

July 10 2014 at 12:57 PM Report abuse rate up rate down Reply

I just got a Home Equity Line of Credit through KeyBank - no closing costs and no fees 3.99% interest - paid off my Citi Card and closed the account. I also have a KeyBank Credit card and have received cash back on everything. This was the best deal around for me.

July 09 2014 at 5:19 PM Report abuse -1 rate up rate down Reply

Or you know.... you can just pay cash and let the small business owner not get raped and save yourself from risking paying interest. A friend of mine told me a tall tale of how he and his wife get a "free" vacation to Disneyland every year with their airline miles through credit card use. I looked into it and did the math. A person would have to spend $9500 a year on their credit cards to just break even on the annual fee to own the credit card. My friend said he was good with money and paid his bills on time so the airline miles were free, but my friend who is a physicist is only fooling himself in the credit card game. Him and his wife pay $180 per year to own their credit cards and x 2 years is $360... Which is about what 2 tickets to Disneyland and back cost in the first place from where we live.

The only way credit cards work is if you own a small business or get reimbursed by your employer and move through a ton of cash buying and selling or travelling. For the average person that just uses credit cards on normal expenses, it's not worth it. Plus, who really keeps a log book on their spending to know exactly what is being spent each month ?... Using a credit card and paying it at the end of the month either makes you susceptible to impulse spending, or turns you into some kind of frugal freak show.. I personally use cash to budget with. When the grocery budget is tapped, nothing else gets bought till next month. When the weekly allowances get spent, the family learns not to be stupid with their money and they have to wait till next week for the money. Both my wife and my youngest daughter are shopaholics, and both have learned to manage their money by only being limited to a weekly allowance. Before my wife met me, she was one of those people deep in debt and totally out of control, yet the credit card companies and everyone else was more than willing to lend to her because as this writer put it... She was the perfect consumer.

I say support your local gas station by using cash... They are only making about a nickel per gallon of gas and when they have to give 2 cents of that to a credit card company, there goes 40% of their profits. If you don't believe me, then look it up. Do a google search on what it is like to own a gas station. Credit Card companies are the bad guy. They are a middle man who makes everything more expensive than it has to be because retailers have to jack up prices to pay the fees. If the consumer would stop using credit cards, prices would drop by around 2%.. So, inflation is actually 2% higher because everyone out there is falling into the credit card scam and trying to win a free cupie doll in the form of airline miles or cash back. No such thing as a free lunch people... If you are getting $50, then that means you overpaid by $500..

July 09 2014 at 2:47 PM Report abuse +1 rate up rate down Reply
2 replies to socioeconomist1's comment

"Him and his wife pay $180 per year "...There are many credit cards out there with no fee.

"who really keeps a log book on their spending"...You don't really have to. Every purchase appears and is totaled on the bank's web site every day.

"Both my wife and my youngest daughter are shopaholics"...That's a personal problem, rather than a financial one.

"They are only making about a nickel per gallon of gas"...They've always made their money from the overpriced merchandise in their stores.

"prices would drop by around 2%"...Possible, but not probable. Merchants would just pocket the savings. Plus, many studies have shown that many people who use credit cards spend more on each visit to the business.

July 09 2014 at 4:34 PM Report abuse +2 rate up rate down Reply

@ socioeconomist1 --- People always tend to spend more when they are whipping out a plastic card to pay for their purchases. It just isn't the same experience as parting with cash out of your wallet. Paying cash makes you much more aware of what you are spending.

Re your comment about gas stations --- I agree with your advice to pay for your fuel purchases with cash. But, don't make impulse purchases inside that little convenience store when you walk inside to pay for your gas. Gas station owners make most of their profits from the overpriced items in their convenience stores --- not out front at the fuel pumps.

July 09 2014 at 6:41 PM Report abuse +1 rate up rate down Reply
1 reply to Valerie's comment

"People always tend to spend more when they are whipping out a plastic card"...It would be more correct to say some people often pay more when they are whipping out a plastic card instead of paying cash. I don't.

Contrary to what SE1 said, at least in my neck-of-the-woods I haven't seen a lot of empty, abandoned gas stations that have gone out-of-business because their poor, beleaguered owners were unable to turn a profit.

July 09 2014 at 8:50 PM Report abuse +1 rate up rate down

Its simple, avoid any card company with flashy commercials period!!!
Stick with credit unions, notice how they dont have flashy commercials trying to bait n switch?
(which should be illegal, but people are stupid enough to fall for it).

July 09 2014 at 2:32 PM Report abuse +2 rate up rate down Reply