With credit cards, consumers typically hear about
For example, credit cards can be completely free if you use them properly. But credit cards are never free for merchants, who must pay a fee to the credit card issuer each time a consumer swipes the card.
Let’s explore five critical details about credit cards:
1. A Credit Card is a Loan
This may be obvious, but a credit card is a loan. Any time you use the card for purchases, you’re not paying the merchant – the bank behind the credit card company is.
The credit card issuer will then send you a list of all your expenditures and require full payment of that amount. The term “buy now, pay later” sums up exactly how credit cards work.
If you don’t pay back that entire balance, that’s when the credit card complexities kick in. For example, interest charges will accrue if you don’t pay the full balance.
2. Credit Cards Have Credit Limits
There is a maximum amount of money you can charge on the credit card. This amount is called a credit limit. If you have strong credit with a long history of little debt and on-time payments, you’ll likely be awarded a higher credit limit.
It’s important that you don’t exceed the credit limit. Sometimes your purchase will be denied if you exceed the credit limit (i.e. if you try to charge $6,000 on a credit card with a $5,000 credit limit.) Other times, the purchase will be approved, but you’ll be slammed with a fee. Check with your credit card issuer for its credit limit policy.
Not to mention, exceeding the credit limit isn’t good for your credit score, as it shows that you’re hungry for credit and it may signal that you don’t have the funds to adequately payoff your debt balance.
3. Credit Card Minimum Payments Are Regulated
Credit card minimum payments are so low, they’re essentially calculated to keep you in debt.
The law said that the credit card company must disclose exactly how much money in interest you’ll owe if you only make the minimum payment. The card issuer also must disclose how many years it will take to become debt free if you only make the minimum payment.
For example, let’s say you have a $2,000 credit card balance with a 20% interest rate. If you only pay the minimum payment, it’ll take you over 15 years to get out of debt. On top of that, you’ll pay almost $3,000 in interest payments. That’s more than your original credit card balance!
If you invested this $3,000 in an exchange traded fund, for example, that tracks the broader stock market, you would be making a significant dent in boosting your retirement savings. Why hand that money to the credit card issuer?
You should aim to payoff the entire credit card balance in full each month. This is the “total balance” line on your credit card statement. Ignore the minimum payment. If you can’t pay the entire balance in full, pay as much of it as you can.
4. Credit Cards Aren’t Always Free
For the most part, credit card usage is free in the sense that you don’t have to pay the credit card issuer every time you swipe the card. Many credit cards charge an annual fee, however. They can be as low as $95 (which isn’t that low) or as high as $495.
In fact, some consumers can be misled, as many credit cards will waive the annual fee for the first year of your new credit card, but charge the fee for each year after that.
Only a few credit cards have no annual fee for the entire life of the credit card. These are the types of credit cards you should have. Why pay a fee just to own a credit card?
In some cases, a higher annual fee results in more substantial rewards programs, such as free access to an airport lounge or waived baggage fees on some airlines. But if you’re not a frequent traveler, it may not be worth paying the annual fee to receive these perks.
5. Retailers Pay a Fee Every Time You Swipe a Credit Card
Even though consumers don’t pay a fee after swiping a credit card, the merchant does. These are called interchange fees and are a vital source of revenue for credit card companies.
The thinking is, the credit card issuer is providing a vehicle for the consumer to spend more money, which benefits the merchant. Plus, when a consumer pays with a credit card, the store doesn’t have to worry about not receiving the money, as would be the case if the consumer had paid with a check. In that case, the merchant may have to worry about the possibility of a bounced check. Certainty of payment, from the merchant’s perspective, may be worth the interchange fee.
A typical interchange fee is 2% on the transaction value. So if you’re buying a $500 television, the retailer will pay roughly $10 to the retailer. This is why smaller businesses will not accept credit cards unless the transaction value is above a certain level, usually $10 or $15. If you’re buying a $3 pack of gum, the merchant generally won’t accept a credit card amid concerns that the interchange fee will eat into the store’s profit margin. Some $33.8 billion in interchange fees was paid by merchants in 2016, according to research firm Moebs Services.