Credit cards are a great tool which enable consumers to spread the cost of large purchases. Problems arise, however, when consumers begin to think of the credit available on their card as ‘free money’. Credit card debt, one of the main sources of consumer debt, can get out of control and consumers find a large part of their disposable income going to service interest payments on past purchases. There are a few hidden costs associated with credit cards, as this article will seek to demonstrate.
1) Interest
Even the least finance savvy credit card holder knows that costs billed to their credit card come at a price. Put a $100 purchase on your credit card and fail to pay the balance at the end of the month, and when the next bill comes, you’ll find that you’ve been charged a few dollars in interest, according to the card’s APR (Annual Percentage Rate). The exact APR will vary according to the card you have, but most credit cards have one thing in common – the APR is far, far higher than many other forms of borrowing.
While not many people are likely to take out a bank loan to book their next holiday, the fact is that in terms of the amounts of interest incurred in paying off a thousand dollars on a credit card over six months, the bank is probably the more efficient option.
Credit cards are an ‘easy’ form of borrowing, but consumers pay for that convenience through very high APRs. Shop around for the lowest APR you can find, if you are not intending to clear your credit card balance at the end of each month.
2) Balance transfers
“0% APR on all balance transfers for the first six months!” Everyone has seen one of these adverts at some point in the last decade, and at first glance they look like a lifeline to people already suffering from hidden credit card costs in the form of interest payments. But look closer.
Lenders that offer customers the opportunity to transfer their existing credit card debt with no interest for six months (or as long as 18 months sometimes) are not doing it out of kindness – they want to make money. And they do so in two ways. First, as soon as the introductory period is up, they will raise the APR to an eye-watering figure, sometimes higher than 20%. If the consumer has not been sensible enough to spend the interest free period paying off their credit card debt, then any saving will be eroded swiftly.
Second, read the small print. Yes, your balance transfer will shelter you from interest charges for six months. But you will usually find that the lender charges you a “transfer fee” – and this tends to be around 2% of the balance. Through a combination of a steep upfront charge, and a high APR on the horizon after the offer runs out, transferring your balance to another card can work out extremely expensive in the long run.
3) Cashback and air miles
Credit card companies want you to use your card. Of course they do! And so they bombard consumers with tempting offers. Get 1% of your purchases in cashback, earn airmiles every time you use your card, gain points with every purchase until you can get a free case of wine in fifteen years time. These schemes seem great, but really they constitute a hidden cost for two reasons.
First, they encourage you to make purchases on credit. These are purchases which you would otherwise made using cash, or perhaps not at all.
Second, you are paying for this stuff. That lovely cashback scheme is all very innovative, but it’s funded by an extra percentage point or two on the top of your APR. Remember, the reason you have a credit card is so that you can make your lender money. Anything which seems to suggest a different relationship is just clever sleight of hand from the marketing people. Even the people who think they’re being incredibly clever by putting work-related purchases on their cashback credit card and then claiming the money back on expenses are victims of this sneakiness.
4) Other tricks
There are a few other costs associated with credit cards that some consumers may not have taken into account. You can incur substantial late fees if you don’t make at least your minimum payment at the end of each month. If you are of a forgetful nature, set up a direct debit to clear the minimum payment on the appropriate day.
People increasingly use credit cards to withdraw cash from ATMs – not only is this subject to an administration fee which can be as much as 3%, but cash advances are often charged at a higher APR. Not only that, but any payments you make towards your balance will be used to pay off the debt on purchases charged at the lower APR first. Use credit cards for cash advances only with extreme caution, and when you have no other alternative.
On a similar note, although the practice has been curtailed in many parts of the world, credit card companies sometimes send customers blank cheques through the post, to use against their card. These have been viewed as misleading (confused customers sometimes think they’re free money), and these also count as cash advances. Shred these as soon as you get them.
Summary
Although credit cards appear to be a free way of increasing your purchasing power, they are not a public service and lenders will extract money at every opportunity through the APR and through various fees and charges. None of these charges are ‘hidden’ in the true sense of the word, as all must be detailed by law in the terms and conditions which you sign when taking on the card, but they can be very obscure. Customers are often fooled by incentive schemes and balance transfers in particular. Read through the terms and conditions for any prospective credit card very carefully to identify where you may incur these costs, and shop around for the lowest possible permanent APR.