Evaluating Credit Card Offers: Essential Terms You Must Understand
Credit card offers, they’re everywhere! They appear in your mailbox. They pop up while you’re surfing the Internet. They’re in slick brochures next to the cash register or gas pump. They’re in full-page ads in the Sunday papers.
If you need a new credit card, how do you choose? You should evaluate each offer carefully, and to do that you must understand these essential terms.
Annual Percentage Rate (APR):
The interest rate charged on your account balance. (But see “Balance Calculation Methods,” because the rules for computing interest from your balance and your APR can vary.) Your statement will usually show the APR and a monthly and/or daily rate based on the APR that’s actually used to calculate your monthly slick cash loan interest. There may be several APRs applicable to different portions of your balance, for example an introductory rate, a regular purchase rate, and a regular cash advance rate.
A fixed APR is set by the credit card company, which can generally change it with as little as 15 days advance notice, especially if you run afoul of any of the “gotchas” in the terms. These “gotchas” are often very consumer-unfriendly. For example, many companies these days reserve the right to raise your rate if you’ve been late on a payment to another, unrelated company.
A variable APR is tied to some widely used economic index, such as the Prime Rate. It may be stated as “prime + x%, currently y%,” for example “prime + 7%, currently 13.5%.” This means that when the Prime Rate is 6.5%, your APR is 13.5%. When the Prime Rate goes up or down, so does your APR. But beware, because some of the same “gotchas” apply to variable APRs as to fixed APRs. Read the fine print. It may state that if you’re late with one payment, your APR will no longer be variable but will rise to an exorbitant fixed rate, usually over 20%.
The penalty APR is the rate to which your APR will immediately be raised when you violate any of the “gotchas” in the terms. This rate is usually at least 50% higher than the regular APR. Again, be sure to read the fine print to see what situations will trigger the penalty APR. You’ll often see these: failure to pay this or any other account on time, exceeding your credit limit on this or any other account, excessive credit balances on your accounts in aggregate.
Balance Calculation Methods:
These are important to understand, because your APR is only part of the story when it comes to calculating the interest you’ll be charged each month. The other part is how the balance is calculated to which the APR is applied. In any case the balance is multiplied by the daily or monthly interest rate. But the balance calculation is not as straightforward as you might think.
1. Two-Cycle Balance. This is the worst method from a consumer’s point of view because it can lead to the highest interest calculations. Unfortunately, it’s also becoming the most widely used method. To calculate the balance, add together the average daily balances for the current billing period (sometimes even including new charges) and the previous period. Here’s why this is so unfriendly to you. Say you have run a balance for a few months and finally pay it from $200 down to zero at the end of May. You think it’s safe to use the card in June for a new $100 purchase, and if you pay the $100 by the end of the June grace period, you won’t owe any interest on it. But you’re wrong. Since your average daily balance in May was not zero (say it was $120), and since you used the card in June, your interest will be calculated on May’s average balance again, so even if you pay the whole June purchase in June, you will still owe additional interest. In other words, you must wait two months, allow the account to cycle once with a zero balance, before it’s safe to use it again – “safe” in the sense that you won’t incur extra interest if you pay the balance in full by the end of the grace period.
2. Average Daily Balance. This was once the most common calculation method and is still popular. Add the daily balance for each day in the billing cycle, then divide by the number of days in the cycle. Depending on the terms, this may or may not include new charges.
3. Adjusted Balance. This is the best method from a consumer’s point of view, but it’s rapidly going the way of the dodo. Take the balance at the beginning of the billing cycle, then subtract any payments or other credits recorded during the cycle. Do not include new charges during the cycle. For example, if your beginning balance was $1200, and you paid $400 during the cycle, the balance to which your monthly rate will be applied is $800, regardless of any new charges.
This means that you’re charging card X to pay off (all or part of) the balance on card Y. So the balance is, in effect, transferred from card Y to card X. Why would you want to do this? Usually to take advantage of an introductory low interest rate when applying for a new card. Look closely at the terms. Sometimes these introductory rates last only a few months. The best ones are for the life of the balance. You will often have to pay a transaction fee equal to 3% of the balance transferred. Sometimes these fees are capped at $75 or so. Be sure to see whether or not the transaction fee exceeds what you’ll save in interest. If so, don’t do it. Sometimes the credit card company will agree to waive the fee, especially on a new account. Don’t be afraid to ask.
A cash loan charged immediately to your credit card account. Usually there is no grace period for paying off a cash advance, which means you’ll be charged interest starting from the day of the loan, even if you pay it in full by the end of the billing cycle. Also this type of charge may have a higher APR than purchases or balance transfers. Check your terms. Note that some kinds of transactions, like buying casino chips or lottery tickets, may be treated as cash advances. This can also apply to writing a purchase check to your own bank account. Be sure to read the fine print.
The upper limit on your account balance. Exceeding it may result in penalties. Be very careful if your balance is close to the limit (“maxed out”), because you can exceed it without charging anything new if you fail to pay enough. Remember that just because the company has approved you for a certain limit doesn’t mean you can afford to take on that much debt.
An important portion of the Terms and Conditions statement. It’s a little bit like the Nutrition Statement on a food package because the law dictates what has to be listed here. If you can’t stand to read all the fine print, be sure that you read this part.
fixed APR or APRs after any introductory rate(s) have expired
rule(s) for calculating variable APR(s) if applicable
annual fee if applicable
minimum per-cycle finance charge
additional fees if applicable, such as cash advance fees
balance calculation method
late payment and delinquency fees
over limit fees
The time, calculated from the account cycle date, during which you can pay the balance in full without having any interest charged. This usually applies only to purchases, and only if you’ve paid the previous month’s balance in full and on time. (Sometimes even that’s not enough. See “Two-Cycle Balance” calculation method for an additional “gotcha.”)
This can be very misleading. It doesn’t mean the company is guaranteeing to issue you the card in the offer. It just means they chose you to receive this offer based on some general screening of your credit report. They always reserve the right to deny or alter the offer based on a more detailed examination of your records.