New Law Prompts Close Look at Your Credit Cards
Recent legislation called the Credit Card Accountability Responsibility and Disclosure Act (CARD Act) brings good news for cardholders. It prohibits some abusive, deceptive lending practices that big banks and national card issuers were using and requires financial institutions to provide clearer information about how much their cards are costing cardholders.
Credit unions didn't use predatory lending tricks to jack up their fee income, so they offer the same value in their credit cards as always. Many banks, on the other hand, are hiking interest rates and charging new fees to replace lost income. It's a great time to evaluate the credit cards you have and determine which ones to use. That analysis makes credit union cards look even better than ever.
Monitor your statementsStart with your credit card statements.
Credit card statements now include boxes that show how long it will take to pay off your balance if you make only the monthly minimum payments—and how much interest you'll pay over that time. They also show how much less interest you'll pay if you make larger payments and pay off the balance in three years.
It can be a real eye-opener. Financial institutions must display the information prominently, along with any changes to interest rates or other important account terms. "That's one of the CARD Act's best consumer benefits—it makes things more transparent so consumers can now be aware of just how deep a financial hole they've dug," says Gail Cunningham, vice president for public relations at the National Foundation for Credit Counseling, Silver Spring, Md.
You can use the information on your statements to compare your credit cards and determine which have the most advantageous terms. You also should continue to monitor your statements to see if the terms change. Card issuers now have to provide 45 days' notice before changing account terms, and new terms generally only apply to new transactions, not to existing balances.
"That's an excellent aspect of the CARD Act," says Linda Sherry, director of national priorities at Consumer Action, San Francisco. "Much of the harm to consumers through higher interest rates was because card issuers were charging them on the entire balance. Issuers can still raise rates as high as they want on new transactions, though."
Cardholders should read their monthly statements and notices they receive from card issuers carefully, Sherry warns. "Because issuers can no longer charge certain fees, and are limited to charging reasonable amounts for others, such as late fees, they may add new types of fees. For instance, now that they can't charge inactivity fees, we're concerned they'll try to get around it by charging an annual fee if you don't use the card a certain number of times."
Credit unions offer the same value in their credit cards as always.
When deciding which credit cards to use, choose the ones with the best terms. If one card has disclosed an interest rate increase or new fees, don't add new transactions to it; just pay off the existing balance as quickly as you can.
Pay on time
Try to pay more than the minimum, and be sure to make all payments on time. Issuers can raise the interest rate on your entire balance if your payment is 60 or more days late.
If you pay even one day late, issuers can charge a penalty rate on new transactions. "And penalty rates can be as high as they want," says Sherry. "The good news is that if an issuer does raise your interest rate, it's required to review your account every six months and decrease the rate if the reason for the increase no longer exists."
Maintain a high credit score
Paying on time is the best thing you can do to improve your credit score, which affects your ability to obtain credit in the future. Five factors determine your score, with payment history accounting for 35% of the score.
Other aspects of handling credit cards affect your score as well. "The second biggest element, which counts for 30% of your score, is credit utilization ratio, or how much you owe relative to your total lines of credit," Cunningham explains. "If you pay your bills on time and don't use more than 30% of your available credit, that accounts for 65% of your credit score." (Some advisers recommend using even less than 30% these days, especially if you're planning to borrow for a house or car in the near future.)
The other factors are longevity, or how long your accounts have been open (15%), how many times you've applied for new credit recently (10%), and whether you're responsibly handling different types of credit (10%).
Apply for credit judiciously. "If you apply for too many accounts, it sends the wrong signal, like you're desperate for credit," says Cunningham. "And the scoring model likes to see that you're managing closed-end loans, like an auto loan, as well as credit cards."
Think before you close accounts
If you're socked with a new annual fee on a credit card account, you may be tempted to close it. If you're carrying a balance, you could transfer it to another card first. But think twice; balance transfers themselves often carry fees these days. And, "If it's your oldest account, it affects your longevity score—the scoring model likes to see that you've handled accounts responsibly for a long time," says Cunningham.
Read your monthly statements and any notices you receive from card issuers carefully.
"It also affects your credit utilization ratio—it's a double whammy," she continues. "Let's say you have total credit limits of $10,000, and you owe $5,000 on one account. If you close another account with a $1,000 limit, without spending a penny you've damaged your ratio. You still owe the same amount, but it's out of a total of $9,000 in available credit."
Your individual situation governs how to handle account decisions. "If you have a high score and have handled credit responsibly, and you're not trying to buy a house or a car, closing an old card probably won't hurt you very much and probably only temporarily," Cunningham says. "But if your score is currently low and you're trying to build it, or you'll need to borrow for a big-ticket item soon, you want to do everything you can to keep your credit score high."
For more information about credit card basics, read the Federal Trade Commission's "Getting Credit: What You Need to Know About Credit."
Home & Family Finance® Resource Center