Avoiding the traps set by credit card companies can help you stop debt from ballooning. To understand how these companies operate, let's take a stroll in their shoes.
A company's best customer is one who brings in the most profit. For credit card companies, this is the revolver -- the customer who pays off debt incrementally while watching his balance steadily grow. The companies actually make little profit from the responsible customer, who quickly and fully pays off balances. The longer you let a balance sit, the longer interest rates will compound, and you'll end up with a large debt. So why do people fall into this trap?
Credit card companies successfully breed the best customers with a simple trick of psychology using the minimum monthly payment. This minimum payment is so tantalizingly low -- often about 4 percent -- that it encourages people to pay just that and put off the rest. Let's say you have a $5,000 balance, but only $200 is required right now. If you're struggling this month, but suspect your ship is just around the corner -- in the form of a raise, an inheritance or whatever -- you'll put off paying more than you have to until then. But paying only the minimum means your large balance will grow even more with interest charges, and it will be even harder to pay more than the minimum next month. For this reason, it's wise to pay off as much of your balance as possible -- preferably your entire balance every month.
Beware of cards bearing low-interest gifts. Credit card companies, like any business trying to sell you something, will use gimmicks to hook you. One of the most popular is a low introductory rate. With this plan, you'll be able to sit on a balance for a few months with only minimal growth. However, just as you get comfortable, the company will switch your nice, low rate with a much higher one. Some people play the game of switching debt to a new card with a low introductory rate every few months -- but this takes work, and so many credit inquiries could do a number on your credit score.
In addition, credit card companies bury hidden fees and rules in confusing, fine-print language. Some point out, however, that heavy federal regulations require this technical language [source: Frontline]. Regardless, it's important for a consumer to understand the terms. For instance, if you exceed your credit limit, you'll get an over-the-limit fee. Even if you're just one day late, you get a bonus -- a late fee. And, despite years of punctual payments, if you slip up one time and pay your bill late, you'll probably have to kiss your low interest rate goodbye.
Another tactic people object to is universal default. Let's say you're a responsible credit card user who never misses a payment and never goes over your limit. You get a letter in the mail telling you that due to a change in your credit score, the interest rate on your credit card is going up. Apparently, the bank told the credit card company you forgot about a car loan payment a few months back. "But, that has nothing to do with my credit card," you argue. However, according to the contract you entered, it does. If you are more than 30 days late with any payment, the credit card company has the right to increase your interest rate [source: Burt].
Find out more about credit and debt with the great links below.
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- CFA. "Push To End Unfair Credit Card Interest Rate Hikes and Fees Gains Momentum." Consumer Federation of America. Press Release. Feb. 14, 2008. (Aug. 1, 2008) http://www.consumerfed.org/pdfs/Push_to_End_Unfair_Credit_Card_Interest_ Rate_Hikes_Gain_Momentum.pdf
- Frontline. "Secret History of the Credit Card." Frontline. Public Broadcasting Station. Nov. 23, 2004. (Aug. 1, 2007) http://www.pbs.org/wgbh/pages/frontline/shows/credit/view/
- Burt, Bill. "'Universal Default' rules explained." Bankrate.com Updated Jan. 25, 2007. (Aug. 1, 2007) http://www.bankrate.com/brm/news/credit-management/20040120a2.asp