Beware the Fine Print

Do you ever wonder what a real credit card commercial would look like? I do. Instead of a retired couple in their mid-50s walking along a beach, you might see a working couple in their mid-30s, at a table with bills scattered everywhere, wondering what to pay first, and how to pay them all.

Indeed, we Americans are piling up debt hand over fist and delivering huge profits to Citigroup (NYSE: C), JPMorgan Chase (NYSE: JPM), American Express (NYSE: AXP), and MasterCard (NYSE: MA) in the process. No doubt they're thrilled; credit issuers are, after all, in the business of making money.

Two-cycle billing
And they do it in many ways, some of which are cleverly disguised. Examples include 0% interest cards that require monthly minimum purchases. Or cash-back cards that promise a 5% rebate while limiting the program to a handful of "qualified" merchants. But those duck-and-weave strategies pale in nastiness to the loathsome two-cycle billing method. Just how despicable is it? Read on.

Two-cycle billing is admittedly confusing. Allow me to explain by first reviewing how credit issuers arrive at interest payments. It all starts with the average daily balance, which is computed by adding the total owed each day and dividing the grand total by the number of days in a billing cycle. A monthly periodic rate is then applied, which is determined by dividing the annual percentage rate by 12. (Example: 18% interest annually becomes 1.5% interest monthly.)

Still with me? Good. Now let's examine how this might affect you. We'll assume you made a significant purchase on June 15 and didn't pay off the balance immediately.

Most credit cards would begin charging you interest on the first day of the new billing cycle in July. In August, interest would be calculated based on the average daily balance held that month, minus payments.

Not so under the two-cycle method. Interest would accrue from the date of the purchase on June 15. You'd be paying at least 16 extra days' worth of interest. And that can prove painful to the Fool who carries a balance only infrequently, CardRatings.com founder Curtis Arnold said in an e-mail interview.

"The good news for consumers is that double or two-cycle billing doesn't have much of an effect on cardholders who revolve a balance every month. The bad news is that it really can hit folks who carry a balance on occasion. ... Our only recourse as consumers is to take our business elsewhere," Arnold said.

Read carefully
Indeed, card issuers have little motivation to help you find out exactly what you'll be paying if you carry a balance. They'd rather you simply thanked them for offering you a "low monthly rate."

Let's use another example. According to CardRatings.com, Morgan Stanley (NYSE: MS) business unit Discover Financial Services has some of the best credit cards available. This shiny, happy offer sure looks good. But how good is it really? We need the fine print to find out.

Once there, I discovered that Discover is one of those to use the two-cycle method for calculating interest. Plus, there are no grace periods for balance transfers. That's hardly punitive, but it also isn't likely to be the best possible deal. (CardRatings.com users may search for cards using many criteria; its list of two-cycle cards may be found here.)

Follow the money
Credit cards can make for wonderful tools. But they can also be exceedingly dangerous, as I've discovered. Hidden fees and unfavorable interest agreements are a big part of the problem. Fortunately, the fine print -- often identified by the phrases "view rates" and "terms and conditions" -- can help you avoid such trouble.

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Fool contributor Tim Beyers thinks it stinks to penalize cardholders for briefly carrying a balance. That's why he won't carry a Discover card. Tim didn't own shares in any of the companies mentioned in this story at the time of publication. Get a peek at everything he's invested in by checking his Fool profile. The Motley Fool's disclosure policy doesn't get enough credit.