What’s the Straight Dope on how credit card interest works? I keep hearing redit card interest being cited as insanely high. 18 to 24% annual percentage rate (APR) is the figure often cited.
So, if I use a credit card to buy something worth $1,000 in cash, I would owe $180 in interest over the course of a year at 18%. Which works about to about $15 per month. That much interest doesn’t sound like a huge nut to crack over a one month period.
What am I missing?
Multiply that $15 a month by the thousands and thousands of dollars of credit card debt that many people are carrying. That’s all you’re missing. I agree, for low balances, it’s no big deal.
Also, until quite recently, the cost of money to banks has been at extremely low levels. Many people believe that the 15 or 16 point spread between the prime rate and the interest rate on cards is unconscionable gouging.
Also, the many people that pay just the minimum payment will roll most of everything over into the next year as well. Minimum payments are set up to leave most of the actual charges right where they are. If someone only pays the minimum payment each month, it can take anywhere from 30 years to never to pay off the balance. The still get to pay interest on it.
Credit cards can be great. They will loan you a lot of money for close to 60 days in some circumstances for little or nothing if you are a savvy consumer. If you pay your bill in full each month, they are largely a free service with many benefits. OTOH, they are also willing to give people limits that they cannot afford to take advantage if they don’t pay it off right away.
A consumer that talks several credit card companies into giving him combined limits of say $20,000 (not uncommon) will owe $300 a month just on the interest alone at 18% and some people’s rate is higher than that. That balance still needs to be paid off some day as well. If that person has a $15 an hour job, over 1/2 of a work week each month is just to pay off credit card interest. Sure they should have known better but the game is rigged to draw those people in and sink them.
If you didn’t have the $1000 to start with, then what’s to say you’ll be able to pay off an extra $180 over a year? A lot of people don’t. So at the end of the year they’ve got an $1180 balance, and still have to charge other stuff because they’re short on cash. Thus the interest keeps compounding and pretty soon they can’t even keep up with the interest. And as long as you keep paying the minimum, they don’t demand you pay the balance, so it’s a problem that is easily put out of sight and out of mind until it’s so enormous that there’s no way to pay it off.
It really sucks, I was up to $8000 at one point I think, but I was lucky and got a good job where I could quickly pay it off. A lot of people aren’t so lucky. I still have credit cards but I never carry a balance more than 30 days.
Not sure if you mean the interest is charged interest of if you mean the amount owed in interest just keeps growing. The former doesn’t happen. Banks, CUs, etc. don’t charge interest on interest.
No, but as of the first day of next month’s billing cycle, last month’s interest is this month’s outstanding balance.
And if you entirely miss a payment, you may get your interest rate jacked up to 20, or even 24 percent.
The money you spend is spent. People who don’t count the credit card debt they have as already spent are in debt further than they realize, even if the first month is interest free. It’s still debt.
Tris
In addition to the interest, there are all kinds of ‘fees’ the credit companies are starting to hit customers with. Often the amounts of these fees are outrageous – up to 250% of the amount owed, and way out of proportion to the actual cost to the company.
Many of these seem to be designed to try to suck some money out of the people who do pay their balance in full every month.
Try 31%. And it’s not necessary to miss a payment. All you have to do is be one day late on a payment. If you’re lucky and you complain about it a lot, they MAY reduce it to 24% after 6 months.
So it’s actually as I thought, you have to incur a LOT of debt without any prospect of paying it off for the interest to be a problem. Not that plenty of people don’t do that.
Thanks for all the informative responses.
I have a corollary question:
Say you never are late or missing on a payment, but you sometimes pay less than your full balance in a given month, but you always pay it off later. Can you still have excellent credit if you do this, or will it be impacted negatively?
And under some card’s “universal default” policy, your Mastercard APR may be jacked up due to a late pay on your Visa card… usually only if you’re at 60 days late…
Just to be clear, at 18% a year you are really paying 1.5% per month, and so the second month you get charged interest on the original 1000 plus 15 in interest. It works out to $195.62 of interest in the first year.
Others have mentioned that the company can raise your interest rate. The other part is that if you are late, or if the added interest pushes your balance over the credit limit, they will add penalties. Plus there are yearly fees.
In my mind, credit card companies use exactly the same business model as loan sharks. They make their profits from interest and fees, knowing that with many clients the principle owed will never get paid off.
Although none of the three credit bureaus will tell you exactly how your credit score is calculated, according to this source and many others that I’ve seen, about 35% of your score is whether or not you pay your minimum on time.
Another 30% is calculated using your credit-to-debt ratio, both per-card and for your overall potential credit. Your credit report is usually laid out like this:
Credit Card #1
Current Balance:
Credit Limit:
High Balance:
Current Standing:
Late Payments:
Credit Card #2
etc…
That’s why credit card companies like Capitol One can wreck your credit even if you pay your balance in full on time every month. They report your high balance as your credit limit, making your credit-to-debt ratio artificially high even if all you’ve ever charged on there was one tank of gas.
That’s also why consolidating your credit debt onto one card can actually hurt your score if that debt equals more than half of the total limit for that card, even if consolidating will lower your interest rate or monthly payments.
Very few credit cards have yearly fees these days, unless you have pretty terrible credit to begin with.
Charge cards (the kind you must pay in full every month) do have high yearly fees since they don’t carge interest.
Susan,
As a nitpick, the three credit bureaus don’t actually score your report themselves in most cases. They buy the scoring “algorithm” for most types of credit score from some nice people at the Fair, Isaac Company [1].
Also, yes, Capitol One’s fraudulent credit reporting practices make me ill and I can’t wait for the lawsuit where they lose their butt over that… or one of their competitors to use it in a negative ad campaign.
Oh well. I bankrupted on a $500 balance with them, so I feel they have more complaints about me than I of them…
[1] www.myfico.com or www.fairisaac.com
Are you kidding? Lenders love customers like that! I would wager it is easier to get credit if you only pay the minimum, rather than paying the balance in full every month. Can’t make exorbitant rates and fees off of conscientious customers.
Erm, well, the credit score has less to do with what a likely irresponsible spender and cash cow you’re going to be. It mostly deals with how much money you can borrow and how reliably you can pay it back. If you’ve got 10 maxed credit cards and pay the minimum every month, not many companies will want to risk being that 11th company because they probably aren’t going to get paid.
Frontline had a highly entertaining and informative show called “The Secret History of the Credit Card”, which I strongly recommend and which one could probably find in a good library.
In any case, the monthly payment is never just the interest. Minimum payments had been, on some cards clearly marketed to people who already had trouble controlling their spending, as low as 2% of the outstanding balance. If the APR was 24% or more, someone who made the minimum monthly payment would never pay off the debt. Recent regulatory changes have raised the monthly minimum to 4%, which at least ensures the debt will eventually be retired, barring missed payments and associated penalty fees.
As a E-Z loan, I admit that $15 a month in interest is pretty piddling and would be easily manageable if you don’t use the card for anything else. Frankly, if you’re smart about it, you can game the system to carry a debt and pay 2.9% or less APR. Getting to this point requires an understanding of how credit cards work, shopping around, and keeping a clean record so you get the better offers.
Or you can contact your bank and look into a non-collateralized line of credit. I have one with an APR of (currently) 9%. Getting that required a decent credit history, though.
You would think so, but that is often not the case. So long as you make the minimum payment each month, new lenders will line up to extend you even more credit. Paying off the principal is not an issue, so long as they get the vig.
Not always. A consumer with lots of cards with high balances on them may get offered more cards, but turned down for them when they actually apply for them with the cc co’s citing too high of an income to debt ratio or too many cards with too high balances as the reason. Many consumers don’t realize that a cc offer is based on a “promotional” review of their credit report, which often is simply a purchased list of names & addresses drawn from the credit bureaus or cc companies themselves. It’s not until they actually look at your real credit report that they decide whether to extend credit. So, credit card offers you get in the mail don’t mean much except that you live in a zip code that trends to certain income levels or you’re on a list somewhere based on demographic data.