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Student Financial Literacy Guide: The Costs of Credit Cards


Using credit cards can be costly. Students should understand and compare the following fees and terms to find the most valuable credit card for their needs.

Understanding your APR

APR, or annual percentage rate, is the interest you would have to pay on your balance after your grace period expires.

Credit card issuers commonly set their card APRs as a function of the federal prime rate. Your credit card’s terms and conditions statement, for example, will commonly express your APR as “U.S. prime rate plus 16.99 percent.” Since the current federal prime rate is 4 percent, that would equal an APR of 20.99 percent for any purchases not paid off by the end of the grace period. Therefore, when federal interest rates rise, your credit card interest rate usually rises too.

For example, the Discover it for Students Card’s terms say that the bank sets its APR by adding anywhere from 9.74 percent to 18.74 percent to the prime rate. With the current prime rate at 4 percent, the actual APR for the Discover It for Students Card is currently between 13.74 percent for those with strong credit and 22.74 percent for those with poor credit who are approved.

How credit card companies calculate your interest

You don’t have to pay any interest charges on purchases as long as you pay off the balance in full by your due date. The amount paid off before then isn’t counted in the total daily balance. If you only pay part of the balance by the end of the grace period, the remaining balance you carry over will accrue interest that will appear on your next billing statement.

Card issuers use different methods to calculate interest charges on the carried balance within a single billing statement. For example, Discover uses the daily balance method. That is, it determines your total interest for each billing statement by calculating your average daily balance of that billing statement (every day’s total balance including the unpaid amount and any new charges) and multiplying it by your daily interest rate (your APR divided by 365). Additionally, if you fail to pay off your entire statement balance by the due date, any new purchases may not receive a grace period and begin accruing interest immediately. Also, cash advances and balance transfers usually begin accruing interest immediately because there are no grace periods on these transactions.

You can quickly fall into a credit card debt hole by carrying a balance and continuing to charge new purchases to your card.

How long will it take to pay off a balance?

If you carry a balance on a credit card, you will have eventually paid off the entire amount you borrowed plus interest. With APRs over 20 percent, the effect of that compound interest can be quite powerful over time.

How much you pay every month toward your balance makes a significant difference in your total interest owed.

The example below shows the money saved on interest from making the bare minimum payment versus a larger payment every month. The starting balance is $1,000 and APR 23.76 percent. The minimum payment is calculated using Discover’s policy, which is the greater of:

  • $35 or;
  • 2 percent of the outstanding balance or;
  • $20 plus interest charges, late fees and fees for debt protection products enrolled in after 2/1/2015

How long will it take to pay off a $1,000 balance at an APR of 23.76 percent?

Starting BalanceMonthly paymentTime to pay offInterest you’ll pay
$1,000$35 (minimum)3 years, 7 months$488.25
$1,000$701 year, 5 months$186.87
$1,000$1001 year$125.44

Doubling your minimum payment from $35 to $70 per month cuts your total interest bynearly 62 percent. For this reason, you usually want to be as aggressive as you can in paying down a credit card balance.

Introductory APRs

Some cards provide an introductory reduced APR, or even a zero percent APR for a number of months after you open the account. For example, the Discover It Chrome for Students card charges zero percent APR for the first six months on purchases and 10.99 percent APR for the first six months on amounts you transfer from other credit cards. Depending on the issuer, this introductory APR may be lost if you miss a monthly payment.

Penalty APR

Some cards charge a penalty APR, commonly 29.99 percent after just one late payment, while others won’t impose a penalty until you’ve been late twice within a six-month or one-year period. Your penalty rate could reset after a certain number of months of on-time payments, or the bank could charge you the penalty APR indefinitely until you pay off the balance.

The best course of action is to maximize your available rewards on the card while avoiding paying interest altogether. “Never carry a balance,” says Harzog.

Cash advance fees

Most credit cards allow you to get cash out of an ATM, but any cash advance usually has an APR greater than the APR on purchases. Most cards will also charge a flat rate ($5 to $10 is common), in addition to an immediate percentage of the cash advance itself. Also, there’s no grace period on cash advance transactions.

Annual fees

Some cards charge an annual fee, usually between $35 and $50. Sometimes card issuers will waive the annual fee for the first year; otherwise, it’s added to your balance on the first bill you receive. Cards with annual fees may have better rewards and benefits than cards with no fees, so it can be worth paying the fee if you use them enough to justify the fee.

Foreign transaction fees

Some cards will charge a fee for overseas or foreign currency transactions, typically between 1 and 3 percent. Some cards may have different fees for different currencies, so it’s important to read your card’s terms, rates and conditions statement before traveling or ordering merchandise from other countries so you don’t get blindsided by foreign transaction fees on your statement.

Foreign transaction fees could be an important consideration for exchange students or students who study abroad.

Late payment fees

If you have a balance and fail to make at least your minimum payment by the due date, your card issuer may charge you a late payment fee, which it will add to your balance on the following statement. For most consumer cards, federal law limits late fees in most circumstances to $27, or $38 for repeated late payments within six billing cycles, as of Jan. 1, 2017.

Some cards, including the Discover It for Students card, do not charge a late fee for the first missed payment. As mentioned above, late payments could trigger a penalty APR of as much as 29.99 percent, in addition to the fees.

Grace periods

The grace period is the time between a purchase and the due date for that billing cycle. You will not be charged interest on any purchases provided you pay your card off before the grace period for that billing cycle expires. However, interest on cash advances and balance transfers may begin accruing immediately because issuers do not often have grace periods for these transactions.

If you don’t pay your new balance in full every month, it’s possible you won’t get a grace period on new purchases. Always understand your card’s terms and conditions if you carry a balance.

What happens if you don’t pay your bill

Failure to pay your credit card bill can lead to serious financial problems. Your credit score will take a big hit, especially if you have accounts sent to collection agencies or listed as defaults or charge-offs. A poor credit score can make it nearly impossible and much more expensive to access credit in the future. It can affect the rates you pay for insurance, and it can potentially hurt your ability to get a job, an apartment, a mortgage and even a cell phone contract.

In some cases, creditors may sue you for damages if you don’t pay your credit card debt. Usually, this only happens if you ignore repeated phone calls and letters. Litigation is expensive, and card issuers usually only file lawsuits against cardholders as a last resort. If they prevail in court, they will receive a judgment against you for the amount you owe, plus court costs and legal fees, depending on the jurisdiction. They can then use this judgment to garnish your wages, seize funds in your bank account or seize or put a lien on other assets that belong to you.

It is better to be responsive to the creditor and negotiate a settlement or a more affordable payment rather than let it go to court.

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