Shop: The Credit Card You Pick Can Save You Money
by Federal Reserve |
| The primary responsibility of the Board members is the formulation of monetary
policy. The seven Board members constitute a majority of the 12-member
Federal Open Market Committee (FOMC),
the group that makes the key decisions affecting the cost and availability of
money and credit in the economy. |
Smart consumers comparison shop for
credit, whether they're looking for a mortgage, an auto loan, or a
credit card. Comparison shopping is important because it could save
you money. When you're looking for a credit card, be sure to
consider the costs and terms. They can make a difference in how much
you pay for the privilege of borrowing. Compare them with the costs
and terms of the cards you already have to find the plan that best
fits your spending and repayment habits.
Key costs and terms to consider are
the annual percentage rate (APR) for goods and services as well as
for cash advances, the annual fee, and the grace period. Also
compare cash-advance fees, late-payment charges, and over-the-limit
fees.
Besides looking at these costs and
terms, think about your typical bill-paying behavior. Do you pay
your outstanding balance in full each month? Or do you usually carry
over a balance? Matching the credit card plan to your needs could
save money.
Credit Card Interest Rates
Credit card issuers offer
variable-rate, fixed-rate, and tiered-rate plans. For variable-rate
credit card plans, the interest rate is calculated according to a
formula. Three of the most commonly used formulas are:
The most common indexes used by
credit card issuers are the prime rate; the one-, three- and
six-month Treasury bill rates; the federal funds rate; and the
Federal Reserve discount rate. Most of the indexes are published in
the money or business section of major newspapers. If the index rate
used for your credit card changes, the rate on your card will, too.
The margin is a number of percentage points chosen by the credit
card issuer. The card issuer also chooses the multiple.
The interest rate on a fixed-rate
credit card plan, though not explicitly tied to changes in another
interest rate, also can change over time. The card issuer must
notify you before the "fixed" interest rate is changed.
A tiered interest rate means that
different rates apply to different levels of the outstanding balance
(for example, 16% on balances of $1 - $500; 17% on balances above
$500).
Some card issuers may have a policy
that raises your interest rate if you make late payments. For
example, if you make 2 late payments within 6 months, the card
issuer may raise your interest rate from 18% APR to 24% APR. If such
a penalty rate applies to your card, the issuer must include a
notice in the solicitation materials.
Card issuers may also charge
different rates for different types of transactions. For example,
the card may carry one rate for purchases of goods and services,
another rate for cash advances, and still another rate for balance
transfers.
How Much Will You Pay?
The finance charge--that is, the
dollar amount you will pay to use credit--depends on your
outstanding balance and the periodic rate in your credit card plan:
What Is the Outstanding Balance?
The
outstanding balance can be calculated in several ways, and the
method of calculation can make a big difference in the finance
charge you will pay:
 |
Average daily balance method
including new purchases. The balance is the sum of the outstanding
balances for every day in the billing cycle (including new purchases
and deducting payments and credits) divided by the number of days in
the billing cycle. |
|
Average daily balance method excluding new
purchases. The balance is the sum of the outstanding balances for
every day in the billing cycle (excluding new purchases and
deducting payments and credits) divided by the number of days in the
billing cycle. |
|
Two-cycle average daily balance method including new
purchases. The balance is the sum of the average daily balances for
two consecutive billing cycles. One daily balance, that for the
current billing cycle, is calculated by summing the outstanding
balances for every day in the billing cycle (including new purchases
and deducting payments and credits) and dividing that total by the
number of days in the billing cycle. The other daily balance is that
from the preceding billing cycle. |
|
Two-cycle average daily balance
method excluding new purchases. The balance is the sum of the
average daily balances for two consecutive billing cycles. One daily
balance, that for the current billing cycle, is calculated by
summing the outstanding balances for every day in the billing cycle
(excluding new purchases and deducting payments and credits) and
dividing that total by the number of days in the billing cycle. The
other daily balance is that from the preceding billing cycle. |
|
Adjusted balance method. The balance is the outstanding balance at
the beginning of the billing cycle minus payments and credits made
during the billing cycle. |
|
Previous balance method. The balance is
the outstanding balance at the beginning of the billing cycle. |
Depending on the balance you carry and the timing of your purchases
and payments, the average daily balance method excluding new
purchases, the adjusted balance method, and the previous balance
method tend to result in lower finance charges than the other
balance-calculation methods.
What Is the Periodic Rate?
The periodic
rate is the rate you are charged each billing period. Usually the
periodic rate is the monthly interest rate, calculated by dividing
the card's APR by 12. If your card has different rates for different
types of transactions, then different periodic rates will apply to
those balances. For example, if your card has a 12% APR on
purchases, the periodic rate for purchases is 1%; and if your card
has a 24% APR on cash advances, the periodic rate for cash advances
is 2%.
The Right Card for You
While the
outstanding balance and the periodic rate are important factors in
choosing a credit card, they shouldn't be your only considerations.
Other plan features may be more important to you, depending on how
you use the card. For example, if you don't always pay your monthly
bill in full, you'll probably be more interested in a card that
carries a lower APR. On the other hand, if you always pay your
monthly bill in full and card enhancements such as frequent flyer
miles don't interest you, your best choice may be a card that has no
annual fee and offers a longer grace period.
The grace period is the number days
between the statement date and the due date during which you can pay
your bill without incurring a finance charge. The card issuer may
refer to the beginning or ending point of the grace period and tell
you about any conditions that apply. For example, the issuer may say
you have "25 days from the statement date, provided you have
paid your previous balance in full by the due date." Keep in
mind that the statement date is not the date on which you receive
the bill; it is the date on which the issuer prepares the statement,
which may be a week or two before you actually receive the bill in
the mail.
How Much Could You Save? The
following example illustrates the annual savings you could achieve
by switching to a credit card plan with a lower APR and no annual
fee. The average monthly balance used in this simplified example is
around the national average for consumers with credit card debt.
| Terms |
Plan A |
Plan B |
| Average monthly
balance |
$2,500 |
$2,500 |
| APR |
x 18% |
x 14% |
| Amount paid in finance charges
annually |
$450 |
$350 |
| Annual fee |
+ $20 |
+ $0 |
| Total cost |
$470 |
$350 |
By switching to a credit card plan
with a lower APR and no annual fee, you could save $120 annually. Of
course, this example assumes that the interest rate is applied to a
constant balance of $2,500 and that you make all payments on time;
if you paid down some of the balance each month, the amount paid in
finance charges annually would be less. Also, if you make a payment
late, you may incur additional fees that will increase your cost.
Credit Card Shopper's Checklist
Here are some tips for shopping for a
credit card or evaluating the cards you already have.
| 1. |
Make a list of features that best fit
your needs, and rank them according to how you plan to use the card. |
| 2. |
Call the issuers of the cards that seem to match your needs to
verify the publicized information. Ask if they have any other plans
available. |
| 3. |
If you are currently a cardholder and have a good credit
rating, ask the issuer of your card to lower your current rate or to
reduce or waive your annual fee. Negotiate. |
| 4. |
Review the following
information about the plans: |
Availability
Is the card accepted
nationally? Regionally? Only in one state? Only in a specific store?
Interest rate pricing
Is the interest
rate fixed? Variable? Tiered? If the rate is variable, what is the
index? The margin? The multiple?
APR
What is the APR for purchases?
For cash advances? For balance transfers? Is there a penalty rate if
you make late payments?
Finance charge
What method for
determining the outstanding balance is used to calculate the finance
charge?
Annual fee
What is the annual fee, if
any?
Grace period
What is the grace period
for purchases? (Grace periods usually do not apply to cash advances,
which begin accruing interest from the day of the transaction.)
Other features
Does the plan offer
enhancements that are attractive to you, such as cash rebates,
purchase protections, warranties or guarantees, travel accident or
automobile rental insurance, discounts on goods and services
purchased, and incentives for use, such as frequent flyer miles? Are
these features available at no extra cost?
Deciphering the Information in a
Credit Card Solicitation or Application
Certain key pieces of
information must be included in all solicitations or applications
for credit cards. Look for a box similar to the one below for
information about interest rates, fees, and other terms for the card
you are considering.
| Annual percentage rate (APR) for
purchases |
2.9% until 11/1/00
after that, 14.9% |
| Other APRs |
Cash-advance APR: 15.9%
Balance-transfer APR: 15.9%
Penalty rate:
23.9% See explanation below. * |
| Variable-rate information |
Your APR
for purchase transactions may vary. The rate is determined monthly
by adding 5.9% to the Prime Rate ** |
| Grace period for repayment of
balances for purchases |
25 days on average |
| Method of computing the
balance for purchases |
Average daily balance (excluding new
purchases) |
| Annual fees |
None |
| Minimum finance charge |
$.50 |
Transaction
fee for cash advances: 3% of the amount advanced
Balance-transfer
fee: 3% of the amount transferred
Late-payment fee: $25
Over-the-credit-limit fee: $25 |
* Explanation of penalty. If your payment arrives more than ten days
late two times within a six-month period, the penalty rate will
apply.
** The Prime Rate used to determine your APR is the rate
published in the Wall Street Journal on the 10th day of the prior
month. |
APR for purchases
The interest rate
you will pay, on an annual basis, if you carry over balances on
purchases from one billing cycle to the next. If the card has a
temporary introductory rate, the rate that applies after the
temporary rate expires is also stated.
Other APRs
The interest rates
you will pay, on an annual basis, if you get a cash advance on your
credit card, if you transfer a balance from another credit card, or
if the card issuer applies penalty rates. (More information on the
penalty rate may be included outside the disclosure box--for
example, in a footnote.)
Variable-rate information
If the card
has a variable rate instead of a fixed rate, this section will tell
you how the variable rate is determined. (More information may be
included outside the disclosure box--for example, in a footnote.)
Grace period for repayment of
balances for purchases
The number of days you have to pay your bill
in full without triggering any finance charges. With most plans, the
grace period applies only to purchases; cash advances and balance
transfers may start accruing interest immediately.
Method of computing the balance for
purchases
The method that will be used to calculate your outstanding
balance if you carry over a balance and will pay a finance charge.
Annual fees
The annual fee (or other
periodic fee) the issuer charges for you to have the card. You may
have to pay this fee even if you never use the card.
Minimum finance charge
Any minimum or
fixed finance charge that could be imposed during a billing cycle. A
minimum finance charge usually applies only when a finance charge is
imposed, that is, when you carry over a balance.
Transaction fee for cash advances
Any
charge imposed when you use the card for a cash advance. If the card
charges transaction fees for purchases, these fees will also be
stated here.
Balance-transfer fee
A fee for
transferring balances from another card to this card, if any.
Late-payment fee
The fee imposed if
your payment is late, if any.
Over-the-credit-limit fee
The fee
imposed if your charges exceed the credit limit set for your card,
if any.
Cracking the Credit Code Glossary of
Credit Terms
Annual fee
A flat, yearly charge
similar to a membership fee
Annual percentage rate (APR)
A
measure of the cost of credit expressed as a yearly rate. Many
credit card plans charge different APRs for credit used in different
ways--for example, one APR for purchases, another for cash advances,
and still another for balance transfers. Some plans may increase the
APR if a payment is late.
Cash-advance fee
A fee charged if you
obtain a cash advance. This fee is in addition to the interest rate
charged on the amount of the advance.
Finance charge
The dollar amount you
pay to use credit. Besides interest costs, the finance charge may
include other charges such as cash-advance fees.
Grace period
A period of time, often
about 25 days, during which you can pay your credit card bill
without incurring a finance charge. Under nearly all credit card
plans, the grace period applies only if you pay your balance in full
each month. It does not apply if you carry a balance forward. Also,
the grace period usually does not apply to cash advances, which may
begin accruing interest from the day of the transaction.
Interest rate
A measure of the cost
of credit, expressed as a percent. For variable-rate credit card
plans, the interest rate is explicitly tied to another interest
rate, such as the prime rate or the Treasury bill rate. If the other
rate changes, the rate on you card will, too. The interest rate on
fixed-rate credit card plans, though not explicitly tied to changes
in other interest rates, can also change over time. The card issuer
must notify you before the "fixed" interest rate is
changed. A tiered interest rate means that different rates apply to
different levels of the outstanding balance (for example, 16% on
balances of $1 - $500; 17% on balances above $500).
Late-payment charge
A charge imposed
when your payment is late. If your payment arrives after the grace
period, you may be charged both a finance charge (the interest on
your outstanding balance) and a late-payment charge. Some card
issuers may also impose a penalty rate if you have more than one
late payment within several months.
Over-the-limit fee
A fee imposed when
your charges exceed the credit limit set on your card.
Penalty rate
The rate that applies
under specific circumstances set out by the card issuer. For
example, if you make 2 late payments within 6 months, a card issuer
may have a policy of raising the interest rate.
Periodic rate
The rate you are
charged each billing period. For most credit card plans, the
periodic rate is a monthly rate, calculated by dividing the APR by
12. For example, a credit card with an 18% APR has a monthly
periodic rate of 1.5%.
For more information go to the Federal
Reserve Board Website.
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