Still stuck in the trap of credit cards? Think that it’s no big deal to carry a balance on your credit card? Yeah – the credit card companies see the word sucker written a ll over your bills. Here’s the truth about credit cards, the stuff they don’t want you to know:
Interest is Compounded Daily
Yes, you read that right. It’s not even a secret if you take the time to actually read all that small print (go get yourself a magnifying glass if you need it – it’s important, or don’t you care about your money?). According to Discover Card’s own website, the interest is compounded every single day based on the APR divided by 365.
Now to put that into terms that normal people understand, let’s say that I loaned you $200 at 20% annual interest. How much interest do you owe me at the end of the year? Sounds like a trick question, doesn’t it? That’s because it is. I know that you’re thinking 20% of $200 is $40 so you owe me $240 at the end of the year, right? Nope.
What the credit card companies do is they charge you the interest Every. Single. Damn. Day. They then get to charge interest on the interest. So basically, they take the 20% annual rate and divide it into 365 pieces. That comes out to a daily interest rate of approximately 0.0547%. You then get to pay the same 0.0547% interest both on the original $200 plus the extra interest which has been added on. Sneaky, huh?
So What Does All This Mean in Real Life?
The money blog I Will Teach You to Be Rich breaks it down for us really well – they said that if you carried a $10,000 balance and then paid the minimum each month, which is $250 (they don’t specify an interest rate but we can assume it’s around 20% which is standard in the industry), you would end up having paid out a whopping $19,000 in interest, paid out over a course of 8 years.
So it’s not really 20% at all. In fact, you’ll end up paying out nearly 200% interest in total, and that’s if you don’t have one of those high risk credit cards with 30% APR.
Another Insidious Trick – Double Cycle Billing
You have to hand it to those credit card companies – they know a good thing when they see it and exploit every legal loophole known to man to suck money from you. Some companies have started to use something called double cycle billing. In essence, it’s a way to charge you interest on money you already paid off.
All Financial Matters has a good explanation of how this works. In essence, what the company does is to bill your interest on the average daily balance over two billing cycles. In essence, the daily interest that you pay out to the card company is based on the average of how much you owed over two months.
So let’s say you owed $1,0000 at the start of the billing cycles and you paid $100 off each month. Your average daily balance using double cycle billing means that instead of paying interest on the $800 you carried after two billing cycles, you pay interest on the average of the previous bill and the average of the new bill (I.e interest on $850 instead of $800), in essence, charging you interest for money you already paid off.
Think Your APR Is Fixed? Sure It Is – Until It Isn’t
A final word about APR: you may think you’ve got this great deal from your card issuer because they gave you a low interest rate. Just one catch – buried in the fine print (got that magnifying glass yet?), it very often says that they can change the APR simply by giving you notice, often just 15 days’ notice.
This is justified because they say that you can opt to walk away and use a different credit card.
Yeah, right – because that $10,000 balance you’re carrying and paying off $19,000 in interest on is just so easy to transfer over to a new credit card, right?
Look folks, credit is important in this world and credit cards can play a valid role. However, like drugs and alcohol, they’re awfully easy to abuse. And when you the get the munchies, you may just find that you’re out of available credit to pay for it because you abused the plastic. Handle with care people.