Credit cards aren’t free money — that should go without saying, but millions of Americans don’t seem to have received that memo.
Americans now owe a record $1.04 trillion in credit card debt.¹ If you’re not careful, credit card debt could hurt your credit score, wipe out your savings, and completely alter your personal financial landscape.
So: debt, debit, both, or neither? Before you apply for that next piece of plastic, here’s what you need to watch out for.
Low interest rates. Credit card companies spend a lot of money on marketing to try to get you hooked on an offer. Often you hear or read that a company will tout an offer with a low or zero percent APR (Annual Percentage Rate). This is called a “teaser rate.”
Sounds amazing, right? But here’s the problem: This is a feature that may only last for 6–12 months. Ask yourself if the real interest rate will be worth it. Credit card companies make a profit via credit card interest. If they were to offer zero percent interest indefinitely, then they wouldn’t make any money.
Make sure you read the fine print to determine whether the card’s interest rate will be affordable after the teaser rate period expires.
Fixed vs. variable interest rates. Credit cards will operate on either a fixed interest rate or a variable interest rate.² A fixed interest rate will generally stay the same from month to month. A variable interest rate, by contrast, is tied to an index (fancy word for interest rate) that moves with the economy. Normally the interest rate is set to be a few percentage points higher than the index.
The big difference here is that while a fixed rate may change, the credit card company is required to inform its customers when this happens. While a variable APR may start out with a lower interest rate, it’s not uncommon for these rates to fluctuate. What’s more, the credit card company isn’t required to tell you about a variable rate change at all!³
Low interest rates are usually reserved for individuals who have great credit with a long credit history. So, if you’ve never owned a credit card (or you are recovering from a negative credit history) this could be a red flag.
Of course, you could avoid these pitfalls altogether if you pay off your credit card balance before the statement date. Whatever the interest rate, be sure you’re applying for a credit card that’s affordable for you to pay off if you miss the payoff due date.
High credit limits. While large lines of credit are usually reserved for those with a good credit history, a new cardholder might still receive an offer for up to a $10,000 credit limit.
If this happens to you, beware. While it may seem like the offer conveys a great deal of trust in your ability to pay your bill, be honest with yourself. You may not be able to recover from the staggering size of your credit card debt if you can’t pay off your balance each month.
If you already have a card with a limit that feels too high, it may be in your interest to request that the company lower your card’s limit.
Late fees. So you’re late paying your credit card bill. Late payments not only have the potential to hurt your credit score, but some credit cards may also assess a penalty APR if you haven’t paid your bill on time.
Penalty APRs are incredibly high, usually topping out at 29.99%.⁴ The solution here is simple: pay your bill on time or you might find self paying ridiculous interest rates!
Balance transfer fees. It’s not uncommon for a cardholder to transfer one card’s balance to another card, otherwise known as a balance transfer. This can be an effective way to pay off your debt while sidestepping interest, but only if you do so before the card’s effective rate kicks in. And, even if a card offers zero interest on balance transfers, you still may have to pay a fee for doing so.
Whatever type of credit card you choose, the only person responsible for its pros and cons is you. But if you’re thrifty and pay attention to the bottom line, you can help make that credit card work for your credit score and not against it.
*¹ Samuel Stebbins “Where credit card debt is the worst in the US: States with the highest average balances,” USA Today (March 7 2019, updated April 26, 2019)
² Latoya Irby, “Credit Card Interest Rates: Fixed vs. Variable Rates,” The Balance (May 20, 2019)
³ Latoya Irby, “Credit Card Interest Rates: Fixed vs. Variable Rates,” The Balance (May 20, 2019)
⁴ Latoya Irby, “Credit Card Default And Penalty Rates Explained,” (August 12, 2019)*