To say America runs on credit would probably be an understatement.
According to recently released data, the amount Americans owed on their credit cards topped $1 trillion, inlcuding student loans and auto loans. This works out to an average monthly balance of approximately $9,600 owed by people who don't pay off their credit cards in full each month.
Furthermore, Ben Woolsey of CreditCards.com found in 2016 that a credit card holder making only minimum payments would be paying out nearly $1,200 a year in interest expenses -- and this figure has likely gone up given that the Federal Reserve has raised its federal funds target rate by 25 basis points three times over the past six months.
Is your credit card costing you money (beyond traditional interest charges)?
Used properly, a credit card can be a valuable asset that makes larger purchases more affordable. It can also be a means to improve your credit score over the long run, which can have a number of positive financial effects.
But when used improperly, or when you don't understand the ins and outs of using a credit card, your access to credit could wind up costing you money in surprising ways. Excluding the most obvious way a credit card costs you money -- the interest you pay on any outstanding month-to-month balance -- here are some lesser-known costs you should be aware of.
1. Annual fees
While there are numerous credit cards you can apply for that have no annual fees attached, an increasing number of reward-based credit cards are passing along an annual fee to their customers. This fee, for top-tier rewards cards and consumers with excellent credit scores, can range from $395 to $550 a year. This means consumers really have to decide if the perks they'll receive are worth the added annual fee of using a rewards credit card.
What's more, consumers can sometimes be baited into spending more than they otherwise would by the promise of significant cash back or rewards for spending "X" amount within the first three or six months of having an annual-fee credit card. In this instance, "X" could be $4,000 or $5,000, if not more. Once again, this means taking the time to run the math in order to see if a rewards card with an annual fee is really worth it.
However, one thing worth keeping in mind is that some credit providers will waive or lower an annual fee upon request. Few credit card customer request an annual fee be waived, and the credit card company certainly isn't going to waive it for you if you don't ask. If you have an excellent credit score, your lender would much prefer to waive or lower your annual fee and keep you as a member than spend the money on marketing to try to replace you.
2. Convenience fees
Another surprising cost that credit card holders should take into account is the possibility that a retailer or point-of-sale provider may tack on a surcharge (convenience fee) for a credit-based transaction. Retailers typically have to hand over a small percentage of their transaction amount to a payment processor like Visa or Mastercard, which means some of these retailers attempt to make up this fee by passing along the cost to the consumer. Though these fees tend to be pretty small, they can add up over time.
But convenience fees can be exceptionally high if you plan to pay your taxes with a credit card. Utilizing a third-party service usually results in a 1.87% to 2% convenience fee on the total balance of what you owe. The convenience fee is even higher if you go through tax preparation software, where fees can jump over 3% in some cases. This means a $5,000 tax bill could result in a $150 convenience fee, on top of the interest you could be charged by your lender if you carry a balance.
3. Lower credit score
A third factor that could wind up impacting your wallet is credit card misuse. In other words, if you don't make your payments on time, or if you use most of your available credit, you could be in big trouble.
Ignoring the front-and-center costs associated with a late payment on a credit card (interest and fees), the bigger issue with a late payment is that it'll likely weigh on your credit score, which ranges from a low of 300 to a high of 850 on the FICO scoring scale. Though FICO's credit-scoring model is a closely guarded secret, timely payments accounts for about 35% of your credit score, and credit utilization works out to another 30%. This means a late payment on an account that's near its limit is a practical double whammy.
If your credit score falls, you could be exposed to a number of additional costs. For example, it could be more difficult to secure a mortgage at an attractive rate. A $200,000 mortgage over 30 years will cost more than $10,000 extra in interest if your rate jumps by just 0.25%. Furthermore, your homeowners and auto insurance rates could rise (since those with lower credit scores are statistically proven to cost insurers more), and you may be required to put more money down when opening a utility account. And all of this is because you mismanaged one or more of your credit cards.
4. Loss of cash-back reward purchasing power
A final way your credit card could be costing you money is through the loss of rewards purchasing power. The good news is rewards typically don't expire, which means you can use them anytime you choose. However, if you choose to hang on to your rewards, especially cash-back rewards, you could find that they've devalued over time.
When you earn cash-back rewards with a credit card provider, they remain available to you but do not gain in value. Rewards can't be invested while on standby, and they don't earn interest. This means if you hoard credit card cash-back rewards, the value of those rewards is constantly being eroded by inflation over time. It's something even this Fool with a perfect credit score has been guilty of.
Thankfully, the solution here is pretty simple: If you've earned cash-back rewards with a credit card, take them as soon as possible. This way, you can realize the benefit of the cash immediately without losing the purchasing power of your reward over time.