What 0% Really Costs You

Posted by Mike Smith :: July 9, 2007 @ 7:18 am

We all know that when something seems too good to be true, it probably is. Yet it can be easy to blindly accept an offer for a credit card promoting a zero percent interest rate for an introductory period.

These 0% interest rate cards tend to have their “advantages” prominently displayed on the front side of the application and their terms and fees hidden inconspicuously in small print on the back of the application. This practice is very common with credit card companies. I mentioned that credit card access checks use similar tactics in a previous post.

How 0% credit cards are advertised to work:

• No interest charged on balance transfers
• A free method to consolidate balances from other cards

How 0% cards really work:

• 0% interest is only for a limited time (often as short as 6 months)
• 0% is only for transfers when you applied, not for new purchases
• A transaction fee (usually around 3%) is charged to transfer your balances
• Your card will have two interest rates, one for purchases and a higher one that your “free” transfers will change over to after the introductory period. There is also typically a third interest rate for cash advances.
• If you’re late with a payment or go over your limit, your introductory period will immediately end and often times a default rate, sometimes up to 30%, will apply.
• Once your introductory period ends, you can’t pay off your balance transfers, which now have a higher interest rate until you pay off all of your other lower interest rate balances first

Once you know how these cards really work, you’ll see how much they can end up costing you. Imagine you transferred $5,000 from other cards, thinking that it would save you some money. First, you would be charged 3%, or $150 as a transfer fee. Let’s say you then used the card for $1,000 in purchases during the first month. If your payment arrived just one day late at the end of the first month, here’s how your situation would play out:

You would be charged your normal interest rate on the $1,000. You would be charged a late fee, likely at least $35 with such a high balance. Your introductory period would end because of your late payment, so your $5,000 transferred balance would be subject to a new interest rate, higher than your normal one. (A typical card that I found online charged a 20% APR for balance transfers once the introductory period ends.) Any future payments that you make would not go towards your $5,000 transferred balance (with its higher interest rate) until the entire $1,000 balance and any subsequent purchases were fully paid off.

It’s easy to see why credit card companies are so happy to offer you 0% interest. They’re not in the business of giving out free money. They are in the business of making money from fees and interest charged to you month after month. If credit cards got you into your current financial situation, it’s foolish to think that they’ll also be able to get you out of it. If you don’t believe us, read these summaries of court cases we pulled from our favorite GAO study:

• In a collections case in Ohio, the $1,963 balance on one cardholder’s credit card grew by 183 percent to $5,564 over 6 years, despite the cardholder making few new purchases. According to the court’s records, although the cardholder made payments totaling $3,492 over this period, the holder’s balance grew as the result of fees and interest charges. According to the court’s determinations, between 1997 and 2003, the cardholder was assessed a total of $9,056, including $1,518 in over-limit fees, $1,160 in late fees, $369 in credit insurance, and $6,009 in interest charges and other fees. Although the card issuer had sued to collect, the judge rejected the issuer’s collection demand, noting that the cardholder was the victim of unreasonable, unconscionable practices.

• In a June 2004 bankruptcy case filed in the U.S. Bankruptcy Court for the Eastern District of Virginia, the debtor objected to the proofs of claim filed by two companies that had been assigned the debt outstanding on two of the debtor’s credit cards. One of the assignees submitted monthly statements for the credit card account it had assumed. The court noted that over a two-year period (during which balance on the account increased from $4,888 to $5,499), the debtor made only $236 in purchases on the account, while making $3,058 in payments, all of which had gone to pay finance charges, late charges, over-limit fees, bad check fees and phone payment fees.

• In a bankruptcy court case filed in July 2003 in North Carolina, 18 debtors filed objections to the claims by one card issuer of the amounts owed on their credit cards. In response to an inquiry by the judge, the card issuer provided data for these accounts that showed that, in the aggregate, 57 percent of the amounts owed by these 18 accounts at time of their bankruptcy filings represented interest charges and fees. However, the high percentage of interest and fees on these accounts may stem from the size of these principal balances, as some were as low as $95 and none was larger than $1,200.

If you want a reasonable way to consolidate your high-interest debt, a loan from Lending Club is a much smarter way to go. First, the interest rates at Lending Club are typically better than those of credit cards (on average 9.25% at Lending Club versus 16% for credit cards). Second, since Lending Club is a person-to-person lending site, the interest you do pay will be going to members of your Facebook community instead of to a credit card company’s bottom line.