Guide to Credit Cards: How Credit Cards Encourage You To Borrow Money
Consumers are encouraged to overspend by the nature of credit cards. We just saw that the credit card companies encourage this in small ways, for example by tiering rewards to how much you spend. When it comes to to borrowing money, however, the credit card companies encourage you big time.
Here's how they do it:
Credit card companies downplay the amount you owe, and highlight the minimum you need to pay to service a loan instead. Take a careful look at the front page of your credit card statement, if you receive one. You'll notice that the most prominent position is given to the minimum payment due. That's the amount you need to pay to borrow the maximum amount possible from the credit card company. The amount you actually owe - the "balance" - is sometimes buried in a list of other numbers, including your previous balance, payments and credits to your account during the prior month, puchases made during the prior month, and "finance charges".
Credit card companies make it easy to get loan approval. Credit card companies tend to evaluate your credit worthiness when you initially apply for a credit card. Once you have the card, it becomes easy to borrow money. There's no further approval process required - you just pay the minimum amount due, instead of the outstanding balance.
Credit card companies may raise your credit limit without asking you. In other words, they pro-actively give you permission to borrow more money, even without you first requesting it.
Credit card companies encourage you to use your credit card as an ATM card. When you receive a credit card, you were probably sent a PIN number so you could use your credit card to withdraw cash from ATM machines. But in contrast to a true ATM card, withdrawing cash with a credit card is a loan, and you'll start paying interest on that loan immediately. To make matters worse, you might find that your credit card company charges you higher interest on cash advances than for purchases. One Providian credit card, for example, charges 10 percentage points higher interest for cash advances than for purchases.
Credit card companies encourage you to write checks against your card. Once you've received your card, you'll probably be sent checks issued with your name on them. But these are different from checks you write against your checking account. If you use one of those checks, you're taking a loan from the credit card company that gets added to your balance, and you'll start paying interest on that loan the moment the check is cashed.
Credit card companies offer you rewards and low rates for borrowing money. Some cash-back or air miles rewards are increased or kick in when you "carry a balance" (ie. borrow money). And credit card companies issue "introductory offers" of zero or low interest rates on loans, in the expectation that many of their customers will fail to repay the loans by the time the low rate expires.
How can you resist these inducements, and use credit cards wisely and for your own profit? That's what we'll look at next.
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