The Good, the Bad and the Ugly of Credit Cards

If you listen to gurus like Dave Ramsey, you may find yourself feeling like you’re listening to a sermon in which the evil character is the credit card rather than the devil. Perhaps the two are interchangeable. Yes, credit card companies use marketing to lure customers with the hope of making tons of money in late fees, interest fees, annual fees, ad infinitum.

One could say this is little different than seminar leaders who use marketing to lure customers with the hope of making tons of money in sales of books, seminars, board games, bobble-heads, ad infinitum, but that isn’t the crux of what I’m writing about. All businesses must make money in a capitalist society. That’s not the point.

Credit cards are not inherently evil. The idea that all credit cards should not be used by all people is a blanket statement that doesn’t reflect reality. Here is where I stand on the issue.

I agree that many people should not be extended credit. Someone who does not handle alcohol should not be given drinks. More to the point, alcoholics should not be given virtually unlimited access to alcohol, much the same way habitual spenders may not be able to handle access to credit.

Despite what should or should not happen, in most cases customers are adults, capable of making their own decisions about spending. If they want to carry a balance from month to month, paying interest fees and possibly other fees as well, it is a free world.

Some will argue that it’s a good thing that fee-payers (let’s call them “Type A” for now) are not restricted because it allows credit card companies to offer cash back bonuses or travel rewards, which can be maximized by responsible customers (“Type B”). These fees paid by Type As (in addition to transaction fees charged the merchants) subsidize Type Bs.

Yes, these reward programs are still not much more than marketing ploys designed to get people in the door and hopefully pay the company lots of extra money (when Type Bs become Type As). But you can beat the credit cards by being completely responsible by paying on time, every time the full balance every month.

Sometimes credit card companies border unscrupulous and will do everything in their power to screw the customer, including shortening the grace period without notice or accidentally mis-billing. A quick call to customer service usually solves this “problem,” but involves a level of intelligence and positive action by the customer. I’ll look at some of these issues in the next part of this series.

Do people spend more with credit cards than they would with cash? It’s certainly possible, but irrelevant if the card user is intelligent enough to spend only what they can cover with cash when the bill is due. What if an emergency arises, like the loss of a job before the due date? The intelligent individual has an emergency fund or another type of plan ready to go in this event.

The Good

Thanks to the generous bonuses offered by credit card companies — once again, to lure customers in in the hope they will screw up — people who are diligent can come out ahead. If the customer watches each step they take as well as every notice from the credit issuer, he can take advantage of the credit card companies rather than the other way around.

When my apartment complex decided to start taking rent payments by credit card again, I was ecstatic. Now, it may not be a good idea for all the tenants in the development to pay their rent by credit card; I can’t speak for their financial situations. Every time I charge rent, I transfer the same amount from my checking account into savings so the money is put aside and earning interest until the bill is due over 30 days later.

This is what businesses call leverage. Basically, the credit card company gives me a free loan every month when I pay my rent with a credit card. You can look at it another way: my apartment complex lets me keep my cash for at least another month. I am free to earn interest on that money in my savings account. This is irony at its most beautiful: Rather than paying interest to credit card companies, I am earning interest on money that was already due to the landlord.

On top of the interest I’m earning, the credit card I use provides me with cash back for every single transaction. I’m earning interest and cash back on a bill I’d have to pay anyway, whether with a credit card or cash. The amount I pay with cash or by credit card is exactly the same. Therefore, paying by credit card is a much better deal for me.

This is the case for many people interviewed by Liz Pulliam Weston for her recent article, People Who Charge Everything.

These “plastic warriors” are determined to charge everything they can to their credit cards so they can maximize their rewards. They don’t carry balances — paying interest would wipe out their benefits — but they put every purchase and bill possible on their cards.

“We figure if we have to pay for something, we might as well be earning something in return,” summed up Winston-Salem, N.C., resident Kelly Piercy, who charges utility, cell-phone and Internet bills, among others.

It’s not about spending more on cards because it’s easier. These are expenses that would have to be paid anyway, and the amounts would not change based on the method of payment.

Another often overlooked advantage to credit cards is the fraud protection they provide. You take risks whenever you engage in any transaction. With a credit card, the risk is that you won’t be able to pay the bill (a risk which intelligent people as stated above will hedge through existence of an emergency fund or plan). With cash (including checks), the risk is you will be defrauded and you will be responsible for the total sum.

Nevertheless, there are a number of caveats to this philosophy. Even the most astute Type B credit card rebate aficionado will encounter many traps. In the next part of this short series, we’ll look at the dark side of credit cards.

This is the second part in a short series about credit cards and the people who use them. If you missed the first part, take a look.

The Bad

If you are a Type B credit card user, you are making money off the credit card companies, not the other way around. Taking advantage of rewards programs isn’t always a walk in the park. The credit issuers make it as difficult as possible for the Type B user to succeed. “The Bad” section focuses on the straightforward ways credit card companies try to take advantage of their customers. For the deceptive methods, just wait until you read Part 3: The Ugly.

Liz Pulliam Weston outlines how companies try to prevent their customers from taking advantage of the issuers. In one example, the author describes the situation with my particular rewards card:

One reader touted the great deal he got on one of his cards: 5% back on purchases made at groceries, gas stations and pharmacies. The only problem: The deal had quietly expired, and the company had reduced the “everyday purchases” rebate on those categories of spending to 2%.

When there are too many Type Bs for the others to subsidize, companies start lowering their rewards. Interest rates are also higher on rewards cards. This doesn’t matter to Type Bs, but lowered rewards with higher interest rates and fees negatively affects the risk/reward balance.

Another major issue for active Type Bs is the credit score. Reward seekers that jump from one credit card to another, opening up new accounts in a short amount of time, will see an effect on their FICO score. This score is used by companies when determining the interest rate a bank may offer when the customer applies for a loan or a mortgage. By chasing the best rewards from card to card, our Type B may screw himself by having to pay thousands more in interest on a major purchase like a car or a house.

Your credit may be checked at other times as well, such as rental applications and certain job interviews. For some people, such as retired folks, FICO score should not be an issue. Keeping it low could mean missed rewards, but this philosophy is certainly not for everyone.

On top of this, some credit card companies cheat by reporting inaccurate (or perhaps “differently accurate”) numbers to the reporting agencies. This is deceptive — and ugly, as I’ll write in Part 3. You can check your credit report free three times each year through annualcreditreport.com and MyFICO allows you to purchase your credit score. (I believe all access to one’s own information should always be free, but life in a capitalist society dictates otherwise.)

Late fees, interest fees, and annual fees are credit card companies’ bread and butter. They will do whatever they can to get people to pay them. Many already do, but those who don’t are targeted with more tricks.

Most credit cards offer a grace period. When your bill arrives, you are not charged any interest until the bill is due, which is usually 25 or 30 days after the statement date. My rewards card started with a 30-day grace period. Most likely due to my consistent on-time payments, one issuer decided to shorten my grace period to 20 days with little or no notice. If I had been using automatic scheduled payments and did not notice the change, my payments would have been late, and I would have been charged a late fee plus interest.

All it took was a simple call to customer service to have them change my grace period back. I didn’t have to speak to a supervisor and I didn’t have to yell. Type As might not have noticed the change or might not have understood the disadvantage of the shorter grace period. Type As are the perfect customers from the company’s point of view.

The last time I missed a credit card payment was many years ago. I had taken advantage of a store “0% for six months” offer in order to purchase a piece of technology I needed in order to do some side business work. Well, they didn’t send a statement one month and my disorganized self at the time did not make the payment. I received the next statement which included a late fee as well as back interest for every payment made so far. It was a shady switch, but it was my fault for missing the payment.

A call to customer service solved my problem. They were surprisingly sympathetic about the unsent statement and agreed to reverse the fee and interest charges. I would never expect that to happen these days. Perhaps one fee would be refunded, but credit card companies seem more unscrupulous lately.

Credit card companies are enablers. The low-hanging fruit of available credit for even those with histories of bankruptcy make it easy for the addict to get a fix. It’s not always people with proven irresponsibility that fall into the trap, however. Credit card companies are great at marketing to college freshmen, many of whom are away from home for the first time and looking for a way to pay for college life expenses.

This is where education must play a role. If parents teach their kids about responsible money management — through modeling appropriate behavior as well as through open discussions, students will be in much better shape when confronted by the free tee-shirt table at New Student Orientation. Without that education, there exists a void or vacuum in the young adult’s brain. Nature abhors a vacuum, and campus credit card marketers eagerly await to fill that void. I touched upon this topic earlier this year when discussing who is to blame for poor money management skills.

This is the third and final part in a short series about credit cards and the people who use them. If you haven’t yed, read Part 1: The Good and Part 2: The Bad. Keep reading for something ugly.

The Ugly

Credit cards are in business to make money. The fact of the matter is whether you are a Type A or Type B user, that is whether you’re paying late fees, interest, and maybe annual fees, or you’re taking advantage of rewards programs and paying full balances on tome every month, they’re still going to make money off of you.

That’s capitalism, and that’s what customers agree to when the credit card application is signed. The difference between Type A and Type B is the first doesn’t control how the company makes money and the latter does control this aspect. But even this control is a matter of debate.

Credit cards are basically ingrained in our society. It is difficult to make purchases online without a credit card, and impossible armed with only cash. The companies use this ubiquity to go beyond the obvious tricks mentioned in Part 2: The Bad and can trick users without their awareness. These techniques are mostly designed to take advantage of the usually-too-smart Type Bs.

Method 1: Two-cycle billing

Most people I’ve talked to about this topic have no idea what two-cycle billing is, even though chances are their credit cards use this tactic. Put simply, if you carry a balance for one month, you’ll be paying interest for two months, even if you pay off the balance right after the first cycle ends. Details here.

Method 2: Universal default

Credit card companies constantly monitor your credit report. If you default on a loan or are significantly late on another credit card payment, any credit card may begin assessing the default interest rate — much higher than the normal interest rate. More here.

Method 3: Over-limit fees

Once upon a time, if you tried to charge more than your credit limit would allow, the purchase would be denied. Now companies allow the purchase, raise your limit, and charge you a fee for the “priviledge.” More here.

Method 4: Due times

Never send a payment too close to your due date. If the payment arrives by mail on the due date, for example at 1:00 pm, but the “due time” was 10:00 am that morning, you’ll be charged a late fee. More here.

There’s more, and I alluded to this in Part 2. Credit card companies report the status of your accounts to agencies like Experian, and your FICO score is also determined by this information. What the credit card companies send is not always correct. When sending your “credit limit” some companies, such as Capital One, send another number.

If your balance is $500 and your credit limit is $25,000, you might think you’re in good shape. However, if the most amount of credit you’ve used on that card was only $750, then some companies will report that your limit is $750. The report will show that you’re utilizing 67% of your available credit rather than 2%. This can cause a big hit to your credit score, and it’s another way credit companies will try to screw their customers.

With all this ugliness, shouldn’t we stop using credit cards completely? That’s the message a number of motivational speakers take. Shouldn’t we listen?

Some people need discipline, particularly those who are stuck in a cycle of increasing consumer debt, like Todd Townsend. They need to be told that their life should be debt free at all costs. Debt is bad, and all items, even cars and houses, should be purchased with cash. People pay money to go to seminars to be told that “debt free” is the way to be and credit cards are evil. (If those seminars accept credit cards for payment, which some do, then I hope you understand the irony and hypocrisy.)

Statements like, “No one should attempt these risky gimmicks,” or, “credit cards are evil,” are over-simplified, faux-philosophical catchphrases whose speakers assume all listeners are running low on brain cells and need to latch on the first thing that sounds helpful. Or less harshly, these lessons are for people who never learned the basic tenets of managing money.

Simple mathematics shows that with all things (such as risk) being equal, in some cases leverage can be used to earn much more money than using cash. This is the theory powering those who take on 0% balance transfer offers. If these offers are used sparingly, the reward gained from interest outpaces the risk of default, but it is tied to the individual. This is also the theory behind almost all people who purchase real estate using a mortgage loan. It’s a dangerous theory for those who are not ready to handle the challenge.

Here’s the thing about these seminars. They have an intended audience which does not include everyone. Dave Ramsey, for example, wants to get people out of debt (and let’s not forget make some money for himself in the process, which is his right). So don’t assume that his advice would apply to anyone not stuck in the cycle of debt.

To go back to the alcoholism analogy, alcoholics must work on ridding their life of alcohol completely. The majority of the public has little problem consuming alcohol responsibly. Even when the alcoholic has recovered, he must be careful not to relapse. But you wouldn’t give the same advice to the alcoholic you would to one who is not addicted.

The credit card companies don’t care whether you’re addicted; they’d prefer that you are. They will offer people credit whether the consumer can handle it or not. It’s up to the individual to make the decision as to what tools they will use. Credit cards are a part of life in this country, and they’re not going away.

Many people can take advantage of credit cards without falling into their traps. Credit can be used as a tool, as businesses leverage debt, to the advantage of the consumer if handled appropriately. Those who are responsible, have studied their own spending habits, have weighed the risks and rewards, and have an emergency plan shouldn’t be discouraged from beating the credit card companies at their own game. It’s not for everyone — not for most — but it can be done.

I’ll end with a question: How would your life be different without credit cards?