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
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)
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)
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.