Understanding Credit Card Agreements and Terms

Most people like surprises; unless they're related to a credit card. Fortunately, creditors are required by law to disclose the terms and conditions of their offers in detail before you sign on the dotted line.

Unfortunately, those terms and conditions can be difficult to understand—the amount of information is as huge as their impact on your finances. Your card’s interest rate, fee policies, and grace period are all extremely important to your overall financial health. Consider this scenario:

• If you have a $5,000 balance on a credit card with an 18% interest rate, it would take you more than 16 years to pay everything off if you made only the minimum monthly payment (3%). During that time, you will have paid more than $4,698.46 in interest charges.
• On the other hand, if you had that same debt on a 4% interest rate card, your 3% minimum payments would result in a total of $593.49 in interest charges. Your debt would be paid off in a significantly shorter (but still pretty long!) 121 months.

When shopping for a credit card, it pays to take the time to read and understand the terms of your agreement. Remember, a credit card agreement is a legally-binding document. 

Need-to-Know Credit Card Terminology

Annual Fee

It is not uncommon for cards with a perceived high value to charge consumers for the privilege of holding the card. These cards usually offer rewards like cash back or airline miles. Before you agree to pay an annual fee, make sure that the reward is worth it. Keep in mind that finance charges can accrue on the fee itself.

If you hold a card with an annual fee, keep track of the renewal date; some cards will automatically renew if you don’t tell them otherwise.

Annual Percentage Rate (APR) on Purchases

The APR is the loan’s interest cost expressed as an annual rate. Rates can vary significantly (typically from 0 to 29%). Credit cards can either have (1) a variable rate, (2) an introductory rate, or (3) a fixed rate.

With variable rate credit cards, the interest rate is computed by adding a set amount (called the margin) to the prime lending rate. Therefore when the Federal Reserve Board raises the prime rate, most variable-rate credit cards will move in direct response.

Other APR

Cash advances, balance transfers, and overdraft advances normally carry higher interest rates than purchases. You should also be aware that your payments may be applied differently for these uses. Called “non-preferred pricing,” a creditor may also choose to charge you a higher APR if you miss payments.

Keep in mind that interest continues to accrue until an account is paid in full, even if you close the account or the account is charged-off and sent to collections.

Grace Period

This is the amount of time you have until interest begins accruing on new purchases. The grace period is normally 20 to 30 days and only applies if you do not carry a balance.

If your card does not have a Grace Period, the card issuer may charge interest from the date you use your card or from the date each transaction is posted to your account.

Method for Computing the Balance

Because finance charges are based on your balance, it is important to know how your balance is calculated. One of the most common type of finance charge is the average daily balance. To calculate your average daily balance, the creditor adds each daily balance together and then divides by the number of days in the month.

Some issuers include new purchases in their calculations; others do not. Other possible methods include the previous balance method (based on the amount owed at the end of the previous billing cycle) and the adjusted balance method (where they subtract payments before calculating the finance charge).

Transaction Fee

Many cards assess fees when you use your card in certain ways. For example, transaction fees are common for cash advances and wire transfers.

Some cards also charge fees for balance transfers and foreign transactions, so make sure you understand these costs if you plan on using these features.

Late Fee

If you make late or partial payments, most, (if not all) creditors will charge you a fee. Fees often range depending on your balance; the higher the balance, the higher the fee.

Since fees are high, consider setting up automatic bill payments to help you to avoid making late payments.

If mailing your monthly payments, try to send your payment at least one week before the due date to avoid these charges.

Over-the-Limit Fee

It pays to pay attention to your balance—fees for charging over your limit typically range from $15 to $40. If you want to charge past your current limit, call your credit card company and ask them to raise your limit instead.

Just remember that an increased limit is not a license to spend.

Watch for Updates to Terms and Conditions

Also, be on the lookout for term changes as a result of the Credit Card Accountability Responsibility and Disclosure Act of 2009 (CARD Act). The CARD Act may change your existing credit card agreement in many ways including how interest rates are increased, how fees are charged, and how payments are applied.  For example, under the CARD Act, over-the-limit fees cannot be charged unless you request that the creditor allow transactions that will exceed your credit limit.

If you are unsure whether or not your card is the best one for you, you can visit sites like Bankrate.com to compare terms. Just remember that not everyone qualifies for every card; this is true even in you receive a “preapproved” offer in the mail. Preapproved offers are still contingent on you meeting the creditor’s qualifications.

Struggling with credit card debt? MMI offers free, confidential debt counseling. We can help you discover which options will save you to most money and make your life easier.