In the absence of careful consideration, credit cards are an easy debt trap. One instance of sudden high expenses for a family can lead to emergency measures to keep life moving. With all the incentives and bonuses advertised by credit card companies, turning to a credit card to keep afloat could likely become one of those emergency measures.
What isn’t advertised or even taught are the hidden or unexpected costs or tactics credit companies implement or employ to keep cardholders in debt for as long a time as possible. These hidden expenses can ultimately require an uninformed family or individual to take up extra jobs to get out of debt, which cuts into the quality of home and family life.
One of the incentives that make credit cards attractive is no loan interest if the amount is paid off entirely within six months. On one hand, this seems like a lifesaver for a sudden $5,000 car-repair bill. On the other, if all of that $5,000 isn’t paid within six months, a higher interest rate kicks in, likely at 29.99 percent, which will not only hold for all subsequent payments but also typically tack $740 of instant debt onto those previous six months as well.
There’s a difference between a minimum monthly payment and paying off the amount within six months. Minimum payments would take about three years to pay off the cost of repairs, not six months. But that’s just the $5,000 cost of repairs. Because of the 29.99-percent interest rate during those three years, about $4,100 will remain to be paid off. Steady minimum payments after that will draw the loan out to about 100 months, or eight and a half years, for a total cost of $1,400, nearly three times the cost of repairs.
But hazards in credit card use go further than that:
- Endless Cycle of Debt
On average, an American family’s credit card debt is about $8,400, contributing to a total debt of over $1 trillion across the country. What’s worse is that it’s avoidable, given proper education. But transparency in the industry is nonexistent. Credit card advertising not only bypasses high interest rates, but also the fact that minimum monthly payments exist to draw out debt as much as possible, which results in a sum yearly gain of $100 billion for credit card companies.
- High Credit Card Rates
Compared to 29.99 percent for the car-repair scenario, standard rates for excellent, fair and bad credit consumers are 16.90, 21.45 and 24.50 percent. Store chains, like Macy’s or The Banana Republic, will go even higher, advertising a purchase-discount incentive to sign up, but at rates as high as 27.49 percent. This is also compounded by minimum payments and an extended balance.
- Extra Fees
Fees are also a part of credit cards. These can include penalty fees, cash advance fees, transfer fees, annual fees and foreign transaction fees, which in 2016, amounted to $163 billion for credit card companies. Nearly half of these kinds of revenues come from consumer fees, which means consumers probably pay as much in fees as in interest rates.
- Incentives Rewarding Needless Spending
Cashback, miles and points come from higher spending on unnecessary purchases. Instead of valuing responsibility, credit card companies reward putting it off. They also encourage using credit cards over debit cards. While a debit card immediately clears small purchases from an account, substantial rewards in credit card programs tempt consumers into a precarious position of letting these everyday purchases accumulate in a credit card balance, prolonging monthly payments already being paid for larger purchases.
- A Consistently-Weakened Credit Score
A new credit card account triggers a “hard pull” or “hard inquiry”, which negatively affects a credit score, on average by between 10 to 20 points. While this can be recovered without much trouble, the real and enduring negative impact on a score is the utilization ratio. The utilization ratio represents how much of the credit card’s limit is used up in debt, or how close to “maxed” it is. In general, more than 30 percent of the limit downgrades a credit score by as much as 30 or 40 points. In the case of the $5000 car repairs, it could be more than six years before the balance gets below 30 percent.
In general, the best route to take with credit cards is to do research, get informed and learn the lessons early to avoid getting caught in an easily-deceptive trap.