Barbara O’Neill, Ph.D., CFP®, Rutgers Cooperative Extension, oneill@aesop.rutgers.edu
There are two types of credit card fees: those that are charged to all borrowers to use a credit card or specific card features (e.g., annual fees and transaction fees for cash advances and balance transfers) and those that have been established to discourage, and indeed profit from, certain consumer behaviors (e.g., late fees and over-the-limit fees). Both types of fees increase the cost of borrowing money. Some credit cards with relatively low interest rates charge high “nuisance fees.” Thus, it is important to understand all credit card terms before applying for a credit card. The interest rate is not the only factor to consider.
Many credit card fees, as well as interest rates, are negotiable. If you are a good customer (i.e., you’ve always made at least the required minimum monthly payment on time), a bank may be willing to waive a one-time late fee or drop (or reduce) a credit card annual fee. You only have to ask. Why are credit card issuers willing to do this? Because it is often cheaper for them to keep an existing customer, even one that pays lower fees or interest, than it is to spend money to attract a new one.
Late fees are one of the most common “nuisance fees” charged by credit card issuers. Just as the name implies, they are a fee for not paying at least the minimum required payment by the due date. Under Federal Reserve rules, late fees are capped at $25 in most cases. A second late payment during the following six billing cycles will result in a $35 fee. In addition, card issuers can’t impose penalty fees that exceed the amount of the violation (e.g., a penalthy of more than $25 for a late $25 minimum payment).
An over-the-limit fee is a fee charged for exceeding the maximum limit on a credit card. When a credit card is issued, borrowers are given a maximum credit limit (e.g., $1,000) against which they can borrow. This credit limit is noted in correspondence when someone is first sent a credit card and also appears on monthly statements. For example, a person with a $1,000 credit limit may have charged $100. Their credit card statement would list these two figures and the fact that $900 of the $1,000 credit limit is still available.
Before the 1980s, most creditors would have not allowed credit card users to charge over their credit limit. Purchases would simply have been denied. Then creditors realized that it was profitable to approve new purchases, allow credit card users to go over their limit, and charge an over-the-limit fee during every billing cycle until the outstanding balance fell below the maximum credit limit. For example, if a credit card’s over-the limit fee is $35 and it took 4 billing periods to fall below the credit limit, a total of $140 ($35 x 4) would be charged. Beginning February 22, 2010, companies accepting a credit card for payment must get a customer’s permission to exceed the customer’s credit limit (and, hence, incur an over-the-limit fee). In addition, only one over-the-limit fee can be charged per billing cycle.
Late fees and over-the-limit fees are examples of “penalty” fees. They are charged only to those borrowers who do something “wrong” such as making a late payment or exceeding their credit line. An annual fee (sometimes called a “membership fee”), on the other hand, is charged by some credit card issuers to every person who uses their credit card simply for the privilege of being able to use it. Annual fees can range from $0 to $75 or more, depending upon the issuer.
Many credit cards don’t charge any annual fee and use this fact to attract customers. The words “No Annual Fee” are stated prominently in their advertisements. Other credit cards do charge annual fees, in addition to finance charges and other charges, such as late fees. Many of these cards with fees are so-called “affinity” cards that are linked with a company or organization that provides some benefit to cardholders. An example is credit cards issued by airlines. Cardholders often pay an annual fee of $50 to $75 for airline-issued cards and earn frequent flyer miles based on the amount charged (e.g., $1 of charges = one frequent flyer mile).
Transaction fees are fees charged by some credit card issuers each time a credit card and/or certain credit card features are used. The more frequently you use these credit cards and features, the more transaction fees you pay. For example, some credit cards charge a fee each time a credit card is used. A typical transaction fee is 50 cents per charge. If you use your credit card ten times in a month, your statement would show a total of $5.00 (10 x .50) of transaction fees. Two very common credit card transaction fees are fees charged for cash advances and fees for transferring a balance from one credit card to another.
Cash advances are cash loans from a credit card account. Most credit card issuers charge a fee for this service. Fees typically range from 1% to 5% of the amount transferred. For example, if you took a $1,000 cash advance with a 4% transaction fee, you would pay $40 ($1,000 x .04). In addition, a majority of credit card issuers charge a higher annual percentage rate (APR) for cash advances than for purchases. Most credit card companies also don’t provide a grace period on cash advances. Interest is charged from the date of a cash advance, regardless of whether the bill is paid in full when received.
Balance transfer fees are charged when consumers get a new credit card and use it to pay an existing balance on another credit card. Typically this is done when the new credit card offers better terms (e.g., a lower APR). For example, a consumer gets a new credit card with Company B and transfers their balance from Company A, which is repaid by their new credit card company. Then they owe the previous balance from Card A on Card B. Balance transfer fees are often 3% or 4% of the amount being transferred. For example, let’s say a consumer is transferring a $4,000 balance to a lower-interest credit card. The new credit card issuer charges a 3% balance transfer fee. Assuming no caps are in effect, a $120 fee would be charged ($4,000 x .03). A borrower would need to calculate whether the total savings on the reduced interest rate would outweigh the balance transfer fee.
Credit card traps are just that: policies that trap unwary consumers into spending more than they have to, to use a credit card. Unfortunately, many people fail to shop around for the best credit terms. They may also not be aware of costly policy changes made by credit card issuers years after they open an account. Even if people are not experiencing financial distress, they may be paying more than necessary to borrow money.
Skip-a-month offers are a common credit card trap. They are used during the December-January holiday season when people have extra expenses for gifts and travel and may have more difficulty paying their credit card bills. A credit card issuer provides a special bill insert or message on cardholders’ statements indicating that they are allowed, and in fact encouraged, to skip the next month’s payment without penalty. Of course, there is “no free lunch.” Interest charges continue to accrue when a cardholder skips a payment.
Another credit trap is credit card insurance, which may also be called a “payment protection plan” or “credit protection.” For a monthly premium, that often gets financed along with purchases at high interest rates, a credit card insurance policy makes minimum monthly payments if someone is unable to earn income due to disability or unemployment. If a cardholder dies, the insurance covers the balance owed. Consumer advocates generally advise against buying credit card-based insurance. This coverage is limited and expensive. The cost is determined by a monthly premium charged per $100 of outstanding balance. Coverage is purchased directly through a credit issuer so there is no opportunity to shop around for better terms. Premiums are deducted directly from a cardholder’s account if he or she agrees to coverage.
The biggest credit card trap by far, however, is discussed in detail in the fact sheet The High Cost of Credit Card Minimum Payments. By paying only the minimum amount owed, borrowers often spend years, if not decades, in debt and pay hundreds, if not thousands, of dollars in interest. As an example, consider a $5,000 balance on a credit card with an 18% interest rate. If minimum payments of 3% of the outstanding balance are made, the debt will be paid off in 16 years with interest charges of $4,567 (total debt repayment of $9,567). If the monthly payment is 6% of the outstanding balance, the debt would be paid off in 7 years, instead of 16, with an interest cost of $1,592 (i.e., interest savings of $2,975 compared to 3% payments).