Hello TTF Community! Today we wanted to shed some light on the credit card industry. Specifically, how credit cards make money off of consumers like you and how you can take precautions to avoid paying into their wealth.
But first, we have a confession to make. It is something we have had a very easy time coming to terms with, but nonetheless, a confession it is. Ms. TTF and I are complete and utter deadbeats.
I know, I know… how could we possibly be okay with this? And why in the world would we admit it to everybody in such a fashion? It’s simple, really, because we are deadbeats in the eyes of the credit card companies. Visa, Mastercard, Discover, and American Express all agree that we are deadbeats.
Why is that? Well, deadbeats is the term your friendly neighborhood credit card companies have given to individuals who consistently pay their credit card statement balances on time, and in full, every time. In effect, if they don’t get paid, they get cranky.
So how do they make their money off of consumers like you? Well, there are many ways (and I mean MANY), but I am going to focus on three of the most basic ways that impact the every day consumer, and how to avoid them.
Basics of Credit Cards
Let’s first do a quick recap over the basics of credit cards and how the billing cycles and payments work from the consumer’s perspective.
To demonstrate this, let’s take my most recent statement from my Citi Double Cash Credit Card. My “July” statement (which I include in air quotes because it includes June and July charges) spanned 6/21/2019 through the statement close date of 7/18/2019.
The total for my “July” statement was $1,000 (rounding for easier math).
The statement balance is the total of all charges incurred minus any payments (or refunds, rewards, etc.) made between the dates of the statement cycle. In our July statement, the statement balance was $1,000.00. This just shows that we swiped our Double Cash card for $1,000 worth of purchases between 6/21 and 7/18.
However, if I don’t check my balance until July 31st, I could have two different balances. One would be the statement balance (the $1,000) and the other would be the current balance. The current balance would be the $1,000 plus any additional charges to the card after the statement close date and minus any payments made after the close date.
Any of those additional charges after the close date will be added to the next statement. For example, I checked the balance of the Double Cash card on July 31st and the current balance was $1,300.00 because we had purchased $300 worth of items in those 13 days after 7/18 (our close date).
Note: Any additional charges after the statement close date are not included in interest charges for that period (if accrued).
Minimum Balance Due
Minimum balance? Yes, credit card companies require you to pay a minimum balance of approximately 2-3% of the statement balance, or $25 to $35, whichever is more, by your payment due date. If you pay less than the minimum balance due, you are hit with a late fee.
In our example, my statement balance was $1,000. Since 3% of $1,000 is only $30, my credit card company ups the ante to a $35 minimum balance due and if I miss paying that $35 by the payment due date, 8/16, then I am hit with a late fee.
My due date to pay my statement balance of $1,000.00 in full is 8/16/2019 (29 days after the statement close date). The time between my statement closing date of 7/20/2019 and the payment due date of 8/16/2019 is known as the “grace period.”
In essence, I don’t have to pay a dime of that $1,000.00 until the payment due date. With that said, I can pay any amount up to $1,000.00, or even more (e.g. the current balance), at any point prior to or on the due date. If I pay the full statement balance by 8/16/2019, I don’t pay a late fee or any interest.
In effect, I borrowed $1,000 for almost a full month, for free, and paid it all back on-time. If however, I didn’t pay anything by the due date, I would have incurred:
- A late fee of $35; and
- Interest charges on the unpaid balance of $1,000
Let’s talk more about those two charges and how exactly credit cards are making money (aka their hoards of wealth).
1. Late Fees
Ever returned a library book late? What is a library you ask? Well, many would ask that, but I am assuming, hoping, or something in between, that TTF readers are fans of the library. Knowledge beyond measure for the price of $0.00? Yes, please.
Anyways, if you return a library book late, they charge you a fee of about $0.25 but it could be up to $1.00 per day. Unfortunately, the credit card companies are not nearly as forgiving, and typically charge considerably more if you are even a day late on paying the minimum balance due.
Responsible Credit Carding Tip: Set Up Automatic Payments for each Credit Card
I don’t know about you, but paying $35 for missing your payment due date is a tough pill to swallow. The good thing is, you don’t have to “remember” a thing. The credit card companies have put tools in place to ensure that you don’t ever miss your payment due date. If you navigate your account online, there is a section that reads “Set Up Automatic Payments.” This is a MUST.
When you get there, you will have to enter the bank account where you would like your payments deducted from. Just make sure this isn’t an account that is always riding the “overdraft fee danger zone.”
There are a few options when setting up automatic payments. First, you can elect to “Pay Full Statement Balance” on or before the due date every single month. While I think this is an excellent practice for most, I admittedly do not select this for my cards.
The second option and the option that the Miss and I utilize is to pay the “minimum balance due.” We set this up to pay the minimum balance two days before the payment due date just to be safe.
Why do we elect to pay the minimum balance versus the full statement balance?
For us, we keep a pretty close eye on our finances. In fact, every Saturday following pay day, we sit down and manually pay all of our credit cards. Yes, I did say all of them because we over-optimize and certain cards have better rewards for certain spending categories – more on that in a later post.
As a result, we are consistently paying our current balances in full, twice a month. This brings our balance down to zero by “paying off the card” two times a month (great for your credit score). The automatic minimum payment is just a safeguard for us in case we have an especially busy month or are traveling.
Check out Miss TTF’s post on tracking your monthly bills.
Late Fee Forgiveness Tip
If you haven’t set up “Automatic Payments” and you have recently been hit with a late fee, there might be a chance to get it waived. There is a handy dandy 800-number on the back of your credit card which will connect you to your credit card company’s customer service team.
BEFORE you call, set up automatic payments for the card. If you don’t, they are most certainly going to recommend that you do. If you do this before the call, you show that you have given some thought on how to prevent this in the future versus just asking them to waive the charge for you.
You can be honest with them, let them know you missed it on accident, and that you understand the consequences of that but are willing to take more precautions to ensure it doesn’t happen again.
2. Interest on Existing Balances
Now on to the second way that credit cards are making money and snatching up your hard earned money. Interest.
I used Credit Karma’s Credit Card Interest Calculator to demonstrate how long our statement balance of $1,000 would take to pay off by only paying the minimum balances each month and how much interest you would pay over that time.
As you can see, the card currently carries a 15.74% APR (Annual Percentage Rate). This is a variable rate and can change and is likely to if you start missing payments or stop paying in full.
However, assuming that it stays a steady 15.74%, it would take 37 months – over three years! – to pay down just one month’s of expenses in full. Over that time, you will end up paying an additional $261 in interest to carry that balance over 37 months.
Now, $261 to carry a balance of $1,000 over 37 months doesn’t seem that bad, and frankly, I would agree. But to be clear, I never condone giving away money like that, it just doesn’t seem terrible for having your balance on someone else’s books. In honestly, the credit card company is only making $7.05 per month on you, how could they get “rich” off of that?
Interest on America’s Debt
Well, let’s put this into perspective because that $1,000 balance is only .000000000970874% of American credit card debt as of August 2019. If you are backing out the math, that means the total American credit card debt comes out to a staggering $1,030,000,000,000. Yes, I did mean to type $1.030 trillion.
This is absolutely, positively coo-coo for cocoa puffs madness, but it is true. As is the case with such statistics, they only seem to get worse year after year after year. I wish, at my very core, we were chipping away at that debt with each passing year, but that is just not the case… yet.
Now let’s illustrate just how expensive credit card interest can be using our $1.030 trillion debt. If everyone in America were to pay the minimum balance due on their debt, to the tune of 3% per month, we would be paying a total of $30.9 billion per month. Even paying that much, it would still take America three years and nine months to pay off that $1.030 trillion balance, assuming no other debt was added (I know this is a laughable assumption, but it makes math easier and who doesn’t like when math is easier).
During that 45 months of debt pay down, the credit card companies would have made $333.2 billion in interest. Averaged out, that comes out to $7.4 billion per month from just one of many of their revenue streams. Not too shabby for them, horrible for those paying the interest.
So what is the solution?
The solution is as simple as they come, but also easier said than done. Do not, and I repeat DO NOT purchase anything on a credit card that you cannot afford to pay cash for.
There is just no other way. Credit cards are an amazing tool IF, and ONLY IF, you can responsibly handle them and the purchases you make. It allows you to keep cash on hand for a smidge longer, you can rack up some nice sign-on bonuses, and accrue cash back and other rewards. Again, this only works if you can pay the full statement balance every month. The rewards earned will never be good enough to offset late payments and/or interest charges.
And this brings us to the third way that credit cards make money off consumers like you…
3. Cash Advances
I truthfully knew very little about cash advances prior to researching this article, but holy smokes do the credit card companies rake it in from this handy little service their offer.
Cash Advances are pretty basic in theory. You take out cash from your credit card and pay them back with interest. Seems simple and basically identical to standard purchases on your credit card. However, there are far more stipulations and fees associated with them. Let’s explain.
How to Use a Cash Advance
There are a few methods to use your cash advance credit limit. The most common way that our credit cards advertise to us is though a cash advance check or a “convenience check.” They often offer to send you blank checks or sometimes even just send them! They are easy to use (hence the appeal) and can be used at retailers or to many service companies.
Some credit cards come with a PIN, allowing you to withdraw the money from a bank or ATM.
Most credit cards will provide you a cash advance credit limit, separate from your standard credit limit. For our Citi Double Cash we have a credit limit of $6,000 and a cash advance limit of $1,500 (significantly lower, as is usually the case).
Interest on Credit Card Cash Advances
The reason cash advances are separate on this list is because their interest works differently than the interest accrued on your standard purchases. As you recall, your standard purchases have a grace period and you aren’t required to pay any part of that balance until the due date. Only after that due date will you start accruing interest on the remaining balance.
However, for cash advances, the moment you withdraw the cash, you start accruing interest immediately. And you will accrue interest daily so the quicker you pay it off (even before the due date) the less you will pay in interest.
And to top it off, the APR on cash advances is not pretty. Our Double Cash card has a 27.49% APR on cash advances in comparison to our 15.74% on our standard purchases. And of course both can vary whenever deemed necessary by the credt card company.
In sum, don’t take out cash advances and do not use this as an emergency fund for yourself. You will pay an arm and a leg more than you should. Instead, try saving your own emergency fund and if you’re terrible at saving, check out the Digit app to save for you.
Why you should consider a credit card
So now that we have discussed the three easiest ways for you to lose your money to the credit card companies, why would you even consider getting a credit card.
The thing is, credit cards allow you an amazing freedom. They allow you to purchase a good or service and pay for it later, also known as floating. Once the purchase has been made, you have that grace period to pay it off. If you don’t pay it off by the due date, the credit card companies smile and kindly charge you a late fee and interest to the tune of 15 – 20%. The credit card companies love, love, love when you don’t pay your statement balance in full.
But when handled responsibly (i.e. paying the balance in full every single month), credit cards can amount to great things. And hopefully you can be credit card deadbeats with us.
Check out a couple of the top credit card hackers to see just how wonderful credit card usage can be (again, and I cannot reiterate this enough, only if they are paid off, otherwise none of these great bonuses even matter!):