Easy Money? Exposing the Hidden Costs of Credit Card Financing

Flowers and Profits®, December 1999

For busy shop owners, credit card financing is an attractive alternative to a bank loan. However, borrowing money on credit cards is expensive. And the tactics used by credit card companies are the makings of financial quicksand. It may seem that you've found solid footing, but in a few months, you'll get that sinking feeling.

Before you decide to finance something on credit cards instead of through a short-term, low-interest bank loan, take a closer look at the hidden charges presented here.

Shrinking Payment Cycles

Although you may have every intention of paying your credit card bill on time, it might be impossible because the closing date on your statement is already a week to 10 days old when you receive it.

Many credit card companies are allowing only 20 days from the closing date for payment receipt. So if you don't pay the bill immediately, you are likely to be charged a late payment fee that can be as high as $30.

That may not be the worst of it. A single late payment can trigger a permanent interest rate increase. Two late payments on some credit cards can boost your interest rate to 26 percent.

Recommendation: When you receive your statement, check the due date and schedule payment at least seven working days in advance. You may want to consider paying your bill online. Check with your credit card company to find out if they offer this service.

Vanishing Interest Grace Periods

Many people believe that they are charged no interest on a credit card purchase if it's paid in full in the first billing cycle. However, this is not usually the case. If you carry a balance forward from month to month, each new purchase begins to accumulate interest at the time it's recorded.

Recommendation: Read the fine print on your credit card contract to learn about your interest grace period. If possible, pay the entire balance due each month to avoid paying excessive interest.

Escalating Interest Calculations

Most credit card companies calculate interest on your average daily balance, taking into consideration both purchases and payments made throughout the month.

However, some use a more punitive method called the "previous balance method" that computes your interest on the outstanding balance at the beginning of the billing period, with no payments taken into account.

Though rare, you can still find companies that use the most favorable adjusted balance calculations that compute interest on your balance at the end of the billing period. The Consumer Credit Protection Act requires that all lenders disclose the annual percentage rate (APR) as well as the total finance charge in dollars. Therefore, calculating the effective cost of your credit is done for you on your statement, but you have to look for the APR number.

Recommendation: Read your credit card contract and statement to determine which type of interest you're being charged, how much you're being charged and how much you're actually paying each month for interest, penalties and fees. If the rate is too high, shop around for a better deal or consider taking out a bank loan to pay off your credit card.

Running Credit Purity Checks

As unbelievable as it might sound, some credit card companies are now running credit checks to see if their cardholders are 30 days overdue on any credit card. If so, they raise the cardholders' rate to as high as 23.9 percent. Their rationale is that if you are delinquent on another card, you are a higher risk for nonpayment.

Recommendation: Pay all of your credit cards on time, even department store cards. Watch the interest rate you are charged each month and question any additional fees or interest rate increases.

Charging a Minimum Finance Charge

Some credit card companies charge a minimum finance charge even when your balance is only a few dollars. Paying a $5 minimum finance charge on a $100 balance is paying five percent per month, or 60 percent a year!

Recommendation: Use a credit card company that does not charge a minimum finance charge.

Differing Credit Limits

Most shop owners are aware of their credit limit, the maximum they can charge on their credit card. However, few people realize that the maximum cash advance limit may be lower than the maximum purchase limit. Exceeding the cash flow advance will result in an over-limit fee charge of $20, $30 or more.

Recommendation: Read your credit card contract or statement to determine your cash advance credit limit.

Requiring Small Minimum Payments

While it might seem generous that your monthly payment is only two to three percent of your balance, the credit card company is not doing you a favor. If you only pay the minimum, you will be paying for your merchandise over a longer period of time and accumulating more interest charges.

Recommendation: Pay as much of the balance due as possible each month. To reduce credit card debt, pay a fixed amount each month regardless of the stated minimum or pay two or three times the minimum amount due.

Charging More for Cash Advances

Many credit card companies justify charging higher interest and fees for cash advances because they consider them to be loans rather than purchases. In addition to an ATM charge that averages one dollar per transaction (but can be as high as $1.75), you may be assessed an up-front fee of two to four percent. With no grace period, interest begins immediately and often at a higher rate than for purchases.

Many companies apply your payments first to the lower-interest purchases and then to the cash advance balance, leaving the higher interest rate in place until you pay off your balance in full.

Recommendation: Don't use your credit card for obtaining cash. Use your card for purchases and conserve your cash supply.

Offering Convenience Checks

Beware of those tempting checks you receive in the mail to put cash in your pocket or to pay off your credit card balances by transferring your account to a different credit card company. If you read the fine print, you may find that you will be charged a transaction fee or check writing fee that will essentially double your cost.

Recommendation: Don't borrow money by using convenience checks. Consult your bank loan officer instead.

Charging Balance Transfer Fees

It's hard not to shop around for better credit card deals with a new, irresistible offer arriving in the mail almost weekly. Many of these deals entice you to consolidate your debt by transferring your credit card balances to their low-interest account. If you check the fine print, however, you may discover that the low interest expires and the account assesses a balance transfer fee. In addition, some companies are charging up to $50 to close a credit card account as a way of discouraging "deal hopping."

Recommendation: Before you transfer your credit card debt to another company, read the fine print to determine your new interest rate. Also check for transaction fees from either credit card company.

In a time of healthy cash flow, don't be lulled into thinking that happy days are here to stay. Put aside a portion of your profits to see you through the leaner months; then you won't even be tempted to rely too heavily on credit cards.