Truth in lending: Finding out about that 703% APR
Thanks to the new truth in lending laws that stem from the Credit CARD Act of 2009 that was passed last year and goes into effect on February 22, credit card companies are going to have to truthfully spell out the charges they inflict -- and the damage we do to our bottom lines -- when we use our credit cards.
Recently, CBS MoneyWatch columnist Kathy Kristof sounded the clarion call when she noted that she had received her Macy's store credit card statement and, there it was in print, the information that her annual percentage rate is a whopping 703.80%!
She didn't believe that was the APR when she applied for it at Macy's over the holidays. It was supposed to be 24.5%, and it does work out where it would be, if she had a high balance on the card. But with a low balance, the APR is much higher.
It's confusing the way these APRs are calculated, and what makes it even more complicated is the monthly minimum interest charge that Department Stores National Bank, which issued Kristof's card, charges. Every month, it foists a $2 fee on any customer who carries a balance (if they pay off the bill in full, that $2 is refunded, Kristof notes).
So that $2 ends up giving the customer a higher APR. MSN Money's blog Smart Spending does a pretty good job of explaining how the $2 makes the APR go so high. But in a nutshell, it involves a lot of math: You take your credit card's average daily balance (the monthly balance divided by 30) and divide it by $24 (the $2 fee times 12 months).
But never mind the dizzying math. After reading Kristof's story, I kept wondering how long it will take to pay off a credit card that has a 703.8% APR.
Unfortunately, finding the answer to that question was harder than I expected. After taking a look around, it seems that online credit card minimum payment calculators have some catching up to do. Most of them assume, for instance, that you're not going to have an APR of 703.80%.
Bankrate.com, for instance, has a great calculator, but it's so 2008, not taking into account that last year, a card debuted with a 79.9% APR. You can only use Bankrate's calculator if your credit card interest goes no higher than 34%.
CNNMoney.com has an easy-to-use debt calculator, but it didn't quite understand the numbers I was attempting to calculate. When I plugged in some figures, I went for a modest $100 debt and paying 4% of it as a monthly minimum payment, so $4. OK, so far, so good, but then when I typed in the 703.8% APR and tried to calculate how long it would take me to pay off the debt, I received this message:
Error. You chose to make minimum payments only. The amount of your payments is not enough to ever pay off your credit card debts. Please adjust your entries.
So I let the calculator come up with a formula for me. It ultimately determined that if I make payments of $36.97 a month, it will take me one year and 11 months to pay off $100 at 703.80%. And once I have, I'll have paid $741.69 in interest.
I tried a few more online calculators, but all of them seemed to be bewildered by my 703.80% APR. That said, an online calculator at CSGNetwork.com suggested that if I pay off a $100 debt (at $4 a month), I could do so in a mere 601 payments, or 50 years.
The long and short of this is that while the numbers are shocking and mind-numbing, nothing's really changed. For starters, credit cards have likely been offering us a 703.80% interest rate or something comparable for some time -- we're just now actually discovering the cold, hard truth.
Second, as always, the APRs aren't to be too feared, provided you pay off your balance quickly and don't let things spiral out of control -- if you do, then, yes, these APRs are the stuff bankruptcies are made of.
And just as financial experts have always encouraged consumers to pay off debts as fast as you can, that advice is still true. It's just now we know how true it really is.
Geoff Williams is a frequent contributor to WalletPop and the co-author of the new book, Living Well with Bad Credit.