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1992-12-20
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CREDIT CARD FEES
We've already briefly discussed how credit issuers make
money by charging annual fees, interest fees, transaction
fees, late fees and over limit fees. Now, let's cover each
in detail.
ANNUAL FEES
As most of us already know, card issuers charge annual
fees of $10 and up just for the privilege of having
their card in our wallet or purse. You get nothing for
this fee, except a card. In 1990, one major issuer of
bank cards raked in over $450,000,000 in annual fee
revenues. It's not hard to see why annual fees are
here to stay.
One way to fight back is to shop for a bank that
charges little or no annual fee. You can also threaten
to cancel your account if the bank won't "waive" the
annual fee. If you're a good customer, they may prefer
to forfeit the annual fee (usually $10 to $25) rather
than lose you as a customer.
Another facet of the annual fee is the additional card
fee. If your spouse has a card issued by your account,
you may be assessed an additional fee. American
Express, for example, charges $30 for each additional
card issued for their Green Card, which is the most
basic card they offer.
INTEREST RATES
Credit Card Users Misled By Banks, Study Charges
By a Wall Street Journal Staff Reporter
Banks overcharge their credit card customers by using
confusing and sometimes misleading ways to calculate
[credit] card interest, a study by a consumer group asserts.
The study, to be released today, accuses banks of
"loan sharking" and urges Congress to force banks to provide
more information to their cardholders than is currently
available.
The complex maze of secret billing tactics and fees
exposed in the study means that millions of consumers are
paying effective interest rates of 30% or more, said Gerri
Detweller, Director of Bankcard Holders of America, a
nonprofit advocacy group based in Herndon, Va. that tracks
credit card rates and fees, which conducted the study.
Although the average interest rate charged by banks have
declined slightly to about 18.2%, the study asserts that
increased use of complicated terms and "hidden" fees have
raised the cost of using credit cards for some consumers.
Citicorp, the largest card issuer in the U.S. denied
it uses some of the practices criticized in the study.
Although the bank conceded it could be a black eye for the
industry, it praised the study, saying it was long overdue
for consumers.
The consumer group, assisted by Abraham Ravid,
professor of finance at Columbia University, tallied the
credit card contracts of about 20 banks.
The Wall Street Journal
Thursday, June 18, 1992
Have you ever wondered why the major credit card issuers
have set up shop in states like South Dakota and Delaware?
If you knew that these states impose no limit on the amount
of interest that credit card issuers can charge their
customers, would that tell you anything about their motives?
Basically, they can charge what the market will bear, which
is about 19.8 percent. This figure "smacks" of the "it's
only $19.95 order now, not later" pitch, which is the
current sum most people will spend on impulse. If you say
$20, they have to think about it. So, when card interest
rates jump to 20 percent, people will start to scream.
What is of primary importance to you are two things: The
interest rate you are being charged and how your interest is
computed. An explanation of the method used must be included
on your monthly billing statement. If and when you find the
explanation, don't expect to understand it, let alone be
able to figure it out. Consider the following example of
credit card interest computations, which appears on a major
credit card issuer's monthly billing statement:
"We figure a portion of the finance charge
on your account by applying the periodic
interest rate to the ``average daily
balance'' of your account (including
current transactions). To get the
``average daily balance'' we take the
beginning balance of your account each day
and add any new purchases, other
adjustments, and any unpaid finance
charges (*see note), and subtract any
payments or credits. This gives us the
daily balance. Then, we add up all the
daily balances for the billing cycle and
divide the total by the number of days in
the billing cycle. This gives us the
``average daily balance''."
It's not hard to see why people are confused. While this
explanation satisfies the letter of the law, it does nothing
to help the consumer understand how interest is calculated.
Fact is, the credit card companies want it that way. By the
way, this example is an explanation of the "straight average
daily balance" method, which is the most commonly used
method. See the explanation that follows in this section.
In theory, there are eight possible ways to compute
interest; we will cover six of these in detail. But first,
it's important to understand the terms "statement date,"
"billing period" and "average daily balance." These terms
will appear frequently in the explanation of interest
computing methods.
Many companies use a billing cycle that is not relative to
the first of the month, yet, it is tied to the "statement
date." The billing cycle is a number of days, called the
"billing period" (usually 29 to 31 days) that follow the
statement date.
Some of these methods also use variations of an account's
"average daily balance." The average daily balance is
calculated by taking an account's total unpaid balance each
day and adding them together. At the end of the billing
cycle, this sum is divided by the number of days in the
billing period. The result is the "average daily balance."
EXAMPLE: At the start of your current
billing cycle, you had a starting balance
of $300. On the 16th day of the billing
cycle, which is 30 days long, you make a
payment of $150 toward your balance of
$300. So, for the first 15 days your daily
balance was $300; during the last 15 days
your daily balance was $150. To figure
your average daily balance you would
compute as follows:
(15 X $300=$ 4,500)+(15 X $150=$2,250)=$6,750
$6,750 ÷ 30 (days in the billing cycle)=$225
(average daily balance)
In this example, interest would be figured using an average
daily balance of $225. Of course, the method for determining
the average daily balance can vary between methods. Still,
understanding the basics of the method will help you better
understand the various methods.
The methods for computing interest are explained below
starting with the most cost effective method, which is #1,
and ending with the most expensive method, which is #6.
#1. ADJUSTED BALANCE -- This is the best method for the
consumer. Interest is figured on unpaid balances that exist
at the beginning of a billing cycle, less any payments made
or credits issued during the current billing cycle. Any
charges made during the current billing cycle are not used
when figuring interest.
EXAMPLE: Your billing cycle begins May 15.
Here, the credit card company uses the
balance due on May 14 to calculate
interest after deducting any payments made
during the current billing cycle (after
May 14, but, before June 15). So, when you
receive a statement sometime in late June,
you are paying interest on May 14's
balance, less any payments made between
May 15 and June 14.
#2. MODIFIED AVERAGE DAILY BALANCE -- This method computes
interest based on the average daily balance during a billing
cycle. The method for computing the average daily balance is
explained on page 15. Interest is charged on the average
daily balance only. Like method #1, purchases made during
the current billing cycle, as well as unpaid finance charges
are not included when computing interest charges.
EXAMPLE: At the start of your current
billing cycle, you had a starting balance
of $300. On the 16th day of the billing
cycle, which is 30 days long, you make a
payment of $150 toward your balance of
$300. So, for the first 15 days your daily
balance was $300; during the last 15 days
your daily balance was $150. To figure
your average daily balance you would
compute as follows:
(15 X $300=$ 4,500)+(15 X $150=$2,250)=$6,750
$6,750 ÷ 30 (days in the billing cycle)=$225
(average daily balance)
Here, interest would be figured on your
average daily balance, which was $225. As
you can see, no interest is charged on new
purchases made during the billing cycle.
So, if your annual interest rate is 18
percent, your interest would be computed
as follows:
$225 X 1.5 percent = $ 3.37
Of course, if you paid your balance in
full, no interest would be assessed.
#3. PREVIOUS BALANCE -- As its name suggests, this method
computes interest charges based on the balance that was
carried over from the previous billing cycle. No interest is
assessed for charges made during the current billing cycle.
Instead, at the end of the billing cycle, interest is
charged on the total purchases that were made during the
last cycle, plus any unpaid balance.
EXAMPLE: Your billing cycle ends May 14
and you have an ending balance of $300.
During the current billing cycle you make
a payment of $100. Also, you charge $50
worth of new purchases to your card. On
June 14, interest would be computed on a
$250 account balance: ($300-$100)+$50=$250.
#4. STRAIGHT AVERAGE DAILY BALANCE -- This method, also
called the "Average Daily Balance Including New Purchases,"
is one of the more commonly used methods for computing
interest. This method is relatively the same as method #2,
except, the average daily balance includes new purchases
made during the billing cycle.
EXAMPLE: Your billing cycle ends May 14
and you have an ending balance of $300.
Each day during the billing cycle your
average daily balance is figured based on
the $300 balance, any new purchases made
on that day, and, any credits (payments
and adjustments) to your account. The
resulting average daily balance is the
amount on which you are charged interest.
This method usually offers a small "grace period," usually
ranges from 20 to 25 days. If your account balance is paid,
in full, by the "payment due date" given on the billing
statement, no interest is charged. But, if your payment is a
day late, plan to be charged interest for the purchases you
made during the past month. Examine your monthly statement
carefully to know what grace period, if any, you are
entitled.
#5. ENDING BALANCE -- Interest is calculated on the account
at the end of the billing cycle. This account balance is
figured by adding the carry over balance from the previous
month to purchases made during the last billing cycle. Then,
any payments made during the previous billing cycle are
subtracted from that amount. The difference is the amount on
which interest is figured.
EXAMPLE: Let's say your billing cycle
always ends on the last day of the month.
On January 31, you had a balance of $200.
On February 10th you paid $100 toward your
outstanding balance. On February 15 you
charged a $50 purchase. When your billing
cycle ended at the end of February, your
account had a balance of $150. Interest
would be figured on the outstanding
balance of $150; at 18 percent per year,
or, 1.5 percent per month, your interest
charge would be $2.25.
As you can see, it does not matter if payments or purchases
are made during the billing cycle. You are charged interest
based on the account balance at the end of the billing
cycle. So, there is no grace period involved.
#6. TRUE ACTUARIAL DAILY BALANCE -- This is the most costly
method for the consumer. Each day, an account's average
daily balance is figured by adding any purchases and credits
to the current unpaid balance. Then, each of these daily
balances are added together and the sum is divided by the
number of days in the billing cycle. In this method, there
is no grace period; you start paying interest when the
purchase is posted to your account. This is the method
commonly used to figure cash advances, which explains why
they're so costly.
EXAMPLE: On June 10 you use your credit
card to take a $100 cash advance. Starting
on June 10, daily interest is charged on
your account's average daily balance,
which in this case is $100.
If, for example, your billing cycle ended
on June 30, you would have paid interest
for 20 days. Not including a cash advance
fee (normally about 1.5 percent, or, a
minimum of $2 per transaction), you would
have paid about $.05 interest per day or
$1. If this loan went unpaid for an entire
year, the interest would be about $20,
plus transaction fees, if any. And
remember, using this method, there is no
grace period or free ride.
There are two other methods used, which are the absolute
worse for consumers: two-cycle average daily balance
including new purchases and the two-cycle average daily
balance excluding new purchases. If you have an account that
computes interest charges using either of these two methods,
look out! When these methods are used, the effective
interest rate can be almost twice that of the six commonly
used methods.
Both of the two-cycle average daily balance methods figure
interest based on a two-month average account balance
instead of one month. The only difference between the two
methods, is one includes new purchases while the other does
not. Credit card companies may use this method when a
customer who typically pays their bill in full each month,
starts making partial monthly payments.
Here, their rationale is that they are merely recouping
interest due them going back to the day of purchase. So, if
you've been a "pay your balance in full kind of person" who
suddenly starts making partial payments, keep a close eye on
your interest charges.
BEWARE THE "TROJAN HORSE" OFFER. During the Trojan War, the
Greeks built a large wooden horse called the Trojan Horse.
The Greeks placed this horse outside the walls of Troy.
Inside the horse, several Greeks warriors hid in waiting
while the rest of the Greek army sailed away. The Trojans
were warned against bringing the horse into their city. But,
a Greek prisoner convinced the Trojans that the horse was
sacred and would bring them good luck; the Trojans pulled
the horse inside the gates of Troy.
That night, as the Trojans slept after their victory
apparent, the Greeks crept out and opened the city gates for
the rest of their warriors, who had returned from a nearby
island. The Greeks took back the city, slaughtered the
Trojans, and burned Troy.
Many low interest credit cards are "Trojan Horse" offers,
which means that at first glance they look like a good deal.
They work by enticing the consumer with an annual interest
rate of 14.75 percent. However, close scrutiny of the fine
print usually will reveal that these offers use the
two-cycle average daily balance method to calculate interest
fees. As we explained above, using this method can almost
double the rate of interest that is charged. So, an
attractive rate of 14.75 percent can turn into an effective
interest rate of 25 percent or more.
Unless you pay your balance in full, every month, don't
invite this Trojan Horse credit card into your household.
Remember, if you should miss paying your bill in full one
month, the credit card company will go back two billing
cycles and charge you interest.
In summary, if you pay your bill in full, every month,
methods #1 - #4 are the best for you as they all have a one
month grace period. Method #1 is the best method overall as
it results in the lowest interest charges, so, you're not
likely to see this method used too frequently. Method #5 and
#6 provide no grace period; you're charged interest on
purchases as they are posted. Method #6 is the worst overall
plan as it results in the highest interest charges.
Remember, method #6 is commonly used to compute cash
advances.
The most common method used is #4. To understand the
difference between #1, the best deal method, #4, the most
common method and #6, the worst deal method, consider the
following: A monthly interest charge of $15 using method #4
would be roughly $24 using method #6, and, $7.50 using #1.
And finally, if you carry a monthly balance on your card,
beware of "Trojan Horse" offers. These offers promise low
interest rates. But, they use the costly two cycle billing
method to calculate interest. As we explained on page 19,
this method can turn an attractive rate of 14.75 percent
interest into an effective interest rate of 28 percent.
It is not really important to fully understand how interest
is computed. But, it is important to know the general
differences and by which method you are being charged. Then,
you can decide if you have the credit company that is best
for you.
TRANSACTION FEES
Transaction fees are almost always associated with
cash advances. A transaction fee is usually a
percentage of a transaction amount or a flat fee. Some
transaction fees are a percentage up to a dollar
amount. For example, one credit card company charges a
2 percent transaction fee, up to a maximum of $10 on a
cash advance. As we explain in the chapter "Credit
Card Cash Advances," transaction fees can make using a
credit card a costly deal.
"LATE" AND "OVER LIMIT" FEES
A "late fee" is a flat dollar amount, or, a percentage
of the account balance that is assessed when your
payment does not reach the credit card issuer by the
payment due date. The amount of the late fee varies
from state to state, and, from bank to bank. In
general, late fees are charged at 2.5 percent of the
account balance, up to a maximum amount (usually $10
to $20), or, $2 to $20 for each late payment.
An "over limit fee" is assessed for each billing cycle
your account is over its established credit limit. The
amount of the late fee varies from state to state,
and, from bank to bank, but, it is customarily $10 for
each billing cycle an account is over its approved
limit.
CREDIT CARD REPLACEMENT FEES
This fee is charged when you ask for a replacement
card for one that has been lost or stolen. This fee
varies from company to company, but, is generally
around $10 per replacement card.
RETURNED CHECK CHARGE
This fee is assessed when you make a payment using a
check drawn against "insufficient funds." Some banks
and credit card companies charge $15 if you send them
a "bad check."
It's important to note that these fees are enormous money
makers for credit card companies. These fees generate
millions in additional revenue each year.
* * * * * End of CREDIT CARD FEES * * * * *
