Read the Fine Print On Credit Cards

Someone sent me this ad from Discover Card (DFS) offering 0% interest on balance transfers*.

In tiny print at the bottom of the page is a link explaining the "*".

Here are Details of the Transfer



click on chart for sharper image

The 0% APR on the balance transfer is good to February (I captured the image last month when it said December), however, that 0% balance transfer costs you 3% up front. Pay the bill off in a month and you just paid 36% annualized interest to transfer the balance.

On a balance of $500 the $39 over-limit fee amounts to 7.8% of your available credit, which is pretty steep and gives the processor an incentive to allow you to go over your limit and collect the hefty fee. Also note that Discover Card uses 2-Cycle Billing.

2-Cycle Billing Defined

Many consumers are unfamiliar with "2-cycle billing."Dr. Don explains how 2-cycle billing works. "It's a way for credit card companies to effectively get rid of the grace period when a cardholder moves from paying off his bill every month to running a balance."

Those who sometimes carry a balance and sometimes not really get clobbered under a 2-cycle billing scheme. It's also horrid for those who have infrequent large balances as Truth About Credit Cards explains.

Two-Cycle Average Daily Balance is a less common APR computation method, though it’s used widely by Discover card and other card issuers. This is typically the most expensive way of calculating APR because it takes into account two months of your average daily balance.

Say you have an average daily balance of $1500 during your previous billing cycle and $500 during your current billing cycle. Though you paid off a good chunk of your previous credit card balance, the two-cycle average daily balance would be calculated as $1000 (the sum of the last two months average daily balance, $2000, divided by 2), not the $500 balance you currently carry.

This would effectively double the finance charge, making it less attractive to carry a high balance on your credit card(s) that employs the two-cycle average daily balance computation method.

Since Discover pays you 1% per month for all transactions (higher for some transactions) you can come out on top if you meticulously pay your bills on time. Let a balance ride and you quickly lose the benefit of the kickbacks.

What About Complicated Pricing?

The Chicago Tribune is writing Complex pricing of credit cards should be simplified.

Pop quiz: what's the interest rate on the credit cards you're carrying? How about the default rate? Do you know what constitutes an event of default? What will trigger a penalty fee or surcharge? How much are those fees? If you're like most Americans, you probably cannot answer many or all of these questions.

Consider this: It's entirely possible that under a common cardholder agreement provision called a universal cross-default clause that your dispute with the cable company over lousy service constitutes an event of default on your credit card. The default bumps your interest rate up to 32 percent, which is applied retroactively to your existing balance and (under another common practice called "two-cycle billing") to the balance you paid off last month.

Credit cards have a complicated price structure. Cards have multiple price points -- annual fees, merchant fees, interest (at several different rates), and assorted back-end fees, such as late fees, over-limit fees and currency conversion fees. This pricing structure makes it virtually impossible to determine the potential costs of carrying a balance.

Credit cards' complex, non-transparent pricing structure also invites abusive fees and billing practices like late fees that do not correlate with either the balance or time a payment is late, universal cross-default and two-cycle billing. If you are among the nearly two-thirds of Americans who do not consistently pay off your card bills in full and on time, then you've probably been hit with some combination of these fees.

The Byzantine complexity of credit card pricing structures makes it impossible for people to possibly use credit cards intelligently and responsibly.

The responsible way to use credit cards is to pay off the entire bill every month, but its getting harder and harder to pay bills on time. Credit card companies are feeling the credit crunch and tightening the screws, enforcing rules that have always existed, but until now they haven't had the need to use.

Although there is talk of Congress passing legislation to increase transparency of credit card pricing and protect consumer rights, don't count on legislation to handle your personal finances. Pay your bills on time and allow yourself to ignore the fine print.

Addendum

I received the following Email from a Discover Card Employee:

I am an employee at Discover Card.

I read your article about Discover Balance Transfer Offers, and found an error. When I clicked on the link to go to the Discover advertisement, it said that the balance transfer rate is valid until February 2009, which is 13 months from now, not 1 month from now, so the 3% balance transfer fee, when annualized is actually 3% (assuming it takes 4 weeks for the transfer to occur, which it also says in the fine print). Please amend or rescind your article.

Jay R.

Jay, what I said was "Pay the bill off in a month and you just paid 36% annualized interest to transfer the balance."

My error was that the annualized interest is 42% not 36% as I stated it.

However, you have a point in that no one has to pay it off for a year which makes it 3% in theory but not practice if one digs deeper into the fine print.

Additional Fine Print

If you are late making a payment, any introductory/special rates will terminate and the Default Rate will apply. If more than 90% of your new balance consists of special rate balance transfers, we may increase your minimum payment due to a maximum of 4% of the new balance if it would otherwise be less than that.

Discover Card is hoping people do one of three things

1) Pay the balance off early at an effective high interest rate as noted above
2) Do not pay it off in a year in which case interest rate on the balance soars
3) Accidentally make a late payment which automatically sends the interest rate soaring to the default rate

Only if someone waits 10-11 months to pay off the bill and is never late does someone come ahead. But wait, there is another little gotcha in that offer that still makes it hard for the consumer to win big. Here it is: If more than 90% of your new balance consists of special rate balance transfers, we may increase your minimum payment due to a maximum of 4%.

I am not going to do the math on this, but those 4% add up. And those 4% monthly payments make the effective interest rates much higher than the 3% annualized rate that Jay claims. Furthermore, someone who forgetfully decides to pay the balance off early really pays through the nose.

I amended the article as requested.
Can Discover Card answer some questions for me?

Questions For Discover Card

• When is Discover Card going to stop hitting people with horrendous over-limit fees?
• How hard can it be for Discover Card to reject transactions rather than dinging someone $39 dollars for being $1 over limit on a small $501 account?
• When is Discover Card going to eliminate 2-Cycle Billing?
• What about that default rate of 28.99%?

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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