How Do Credit Cards Really Work: Debunking the Myths

Credit cards account for 20% of grievances (second only to mortgages) filed with The Consumer Financial Protection Bureau, the federal agency committed to consumer financial protection. Billing disputes, interest rate charges, and credit reporting top the list of issues consumers submit to the CFPB on a regular basis. Credit cards seem simple enough: buy now, pay later. However, the fine print terms can be confusing and frustrating to even the savviest consumer. Given the massive amounts of misinformation out there, here’s what you may be missing.

What You May Not Understand about Interest Rates

Shopping for a credit card usually means wading through piles of introductory low-rate or 0% APR offers. It’s after the initial rate expires that the ‘fun’ begins.

Myth: A fixed rate can never change.
A credit card with a fixed rate of interest can change for a number of reasons, including late payment, changes to your credit score, or the introductory period coming to an end. Since the Credit CARD Act went into effect in 2009, you must receive written notice of a rate hike, so it’s always important to read those cryptic little plain-envelope notices that you receive in the mail from your credit card company.

Myth: Each card has one, uniform interest rate.  
The interest rate you pay will often vary for the type of charge. For example, merchandise purchases usually have a lower interest fee than those charged for cash advances or balance transfers. And if you miss a payment, or make a late or partial payment, you can be levied a much higher “penalty rate.”

Myth: All credit card companies have the same “grace period.”  
The grace period is the time between the end of the billing period and the day when interest rate charges are applied – and generally apply only to purchases, not cash advances. Pay your balance in full before the end of the grace period and you won’t be charged any interest. This time-frame will generally vary from 20 to 30 days between credit card issuers.

What You May Not Understand About Credit Limits

Myth: With no credit limit, you can spend as much as you want.  
Some “premium” credit cards are issued without an established credit limit. While it may look like you’ve been issued a blank check, remember this is not a gift – you are going to have to repay whatever the debt may be. The reality is the limit exists, even though it may be unseen to you. The limit will hit you square in the face when your credit card is declined by a cashier.

Myth: Exceeding your credit limit is no problem.  
Some cards allow you to spend beyond your approved limit, but may charge an over-the-limit fee in exchange for the flexibility. Experian, one of the main credit reporting agencies, says a one-time approval of a purchase over your limit that is quickly repaid probably won’t affect your credit score. However, your credit report takes into account your current balances and compares them to your available limits, so if you consistently push and exceed the limit, your rating will take a hit. And you will likely get another one of those little notices in the mail from your credit card company notifying you your interest rate has been raised.

Myth: With a boost in your credit limit, you can spend more.
Well, you certainly can, but should you? Credit card companies determine your credit limit based on your history of spending and payments. That’s all they know. They don’t know anything about your salary or household budget. Regardless of your credit availability, only you know – or at least should know – what you can afford.

What You May Not Understand About Your Credit Score

Myth: Getting a credit report will affect your credit score.
In the credit reporting biz there are two types of inquiries: “hard” and “soft.” A hard inquiry, or “hard pull,” is made with your signed authorization by a creditor such as a bank, credit card issuer, or insurance company (who use your credit rating as a factor of risk that affects your premiums). These inquiries may only impact your credit score by a few points, but will remain on your credit report for up to two years. A soft inquiry takes place when you check your own credit report, or when background checks are made by potential employers or for “pre-approved” credit card offers. These inquiries have no impact on your credit score.

Myth: Closing credit accounts will improve your score.
Let’s go to the board on this one. Here’s a big circle. That’s your credit limit. The smaller circle inside the big circle represents balances you currently owe. The difference between the two circles is your credit utilization, or balance-to-limit ratio. If you have a credit card with a long history and a zero balance, closing it will make the big circle smaller, lowering your available credit, and raising your balance-to-limit ratio. In other words, having more credit available to you – and not using it – enhances your credit score. The best idea is to keep paid-off accounts open and unused.

Myth: Settling a debt will take the blemish off your credit report.  
Only time heals credit wounds. Paying off a past-due debt will not eliminate it from your credit report. No one can remove it — not as a favor or for a fee. The credit score scar will linger on your report for at least seven years.

What You May Not Understand About Credit Card Repayment

When your credit card statement arrives in the mail, take a breath and spend a moment reviewing the details. If you see any charges you don’t recognize, be sure to verify them with that wrinkled stack of receipts under the stack of mail on your desk. You generally have 60 days to report billing errors to your credit card company. Beyond that, they can deny your claim without further inquiry.

Myth: Paying off all your debts will give you a perfect credit report.
Oh, if only. You say you paid off everything? How’s that feel? Well, keep that warm and fuzzy feeling going, because your credit report is a history of repayments, and as such your recent fiscal behavior will take awhile to reflect on your credit score. But it does feel good, doesn’t it?

Myth: Pay the minimum due each month and you’ll be fine.  
Paying the minimum amount due on a $2,000 balance at 11% interest will take you 11 years to pay off, according to the Federal Reserve System’s credit card repayment calculator. During that time, you’ll pay almost $1,200 in interest and your credit rating will sag along with your good nature. Paying just the minimum is never a good idea.

Myth: You should always pay old debts.  
Well, this is one for the old moral compass — but from a purely financial standpoint, if a debt exceeds your state’s statute of limitations, you won’t necessarily have to pay. Collection agencies are forbidden by law to pursue debts beyond certain time limitations. For example, the statute of limitations on credit card debts can be as long as 10 years, according to the Federal Trade Commission. Most states impose a period of three to six years. Paying even a partial amount towards the debt can nullify the statute of limitations and rekindle the interest of debt collectors.

Hit and Myth

Searching for accurate credit card information on the Internet can be a hit or miss proposition. There’s a lot of noise out there in the Wild, Wild Web, and there’s a lot of people trying to sell you information you can get for free. It’s best to read the account information provided by your credit card company and then call them with any questions.

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