'Tis The Season for Credit Card Warnings
No matter how much money you have to spend on gifts, we all love those big signs advertising 30 percent off, 50 percent off or even more. But if it takes you many months to pay off the credit card bill, you might as well be shopping at the "I'll pay an extra 20 percent" rack.
"The goal should be to pay off the your credit card balances, if not immediately after the holidays, then within a few months," according to Linda Sherry, a spokeswoman for the advocacy group Consumer Action. "Gauge what your payments would be with the goal of paying it off by March, if you can't do it all in one fell swoop." If you pay off a substantial portion of the total bill, Sherry says your interest payments will be relatively small. But if you carry that debt for many months, the interest will continue to mount and negate a lot of the bargain price you worked so hard to find.
What Do Those Gifts Really Cost?
Let's say you splurge on a high-def TV and a trendy designer pocketbook, running up a credit card bill of $4,000. If you pay it off when the bill comes in, there's no interest. If you pay it off in three equal monthly payments at 12 percent, it will cost an additional $81 in interest; and if you pay $500 per month, it will take you nine months with total interest payments of $190 (assuming that you don't run up any additional credit card debt along the way). Play around with the numbers on free credit card calculators before making a big purchase to see how much it will cost you in interest under different payment scenarios.
If you miss a payment or fail to pay the monthly minimum, you'll be hit with a late fee of $25 to $35. And if you miss two months in a row, you basically go to credit card jail. You are then subject to a penalty interest rate that could top 30 percent. A Creditcards.com survey of leading credit card issuers found the average penalty interest rate is 28.45 percent. If you fall into that trap, the $4,000 of feel-good purchases would cost an extra $665 in interest over the course of a year.
If you know that you won't be able to pay off your bill in full, "it can be a good idea to take advantage of the auto-pay feature offered by your bank," said Matt Schulz, senior industry analyst at CreditCards.com. "If you set aside $50 or $100 every month and have the bank pay that automatically, it can help you avoid falling into the penalty trap." He says the penalty applies to both new and old purchases. "When you're hit with a penalty rate," says Schulz, "things can get out of control in a hurry." He says that once you fall into the penalty category, it will take you six months of making on time payments to be "cured" and escape the extremely high penalty rates.
Paying the Penalty
Fortunately, the number of people who fall into the penalty box has declined as the economy recovers and the unemployment rate falls. In addition, Schulz says the number of issuers who impose this penalty has declined since the Credit Card Accountability and Disclosure Act was passed in 2009. CreditCard.com says 60 percent of card issues impose penalty rates now, down from 91 percent in 2010. However, business credit cards are exempt from the CARD Act and are often subject to the harshest penalties.
So before you hit the mall or start buying online, Sherry suggests that you look over your bank account for the past six months to get a good idea of how much money was left over for discretionary spending -- and keep an eye on your current credit card balance. "Be frank with yourself about why you're using credit. Can you afford the purchase? Keep track of what you're putting on the card. It can get out of hand pretty quickly."