Understanding the Mathematics of Personal Finance

Credit Cards

Credit cards are such an integral part of our society that it’s hard to imagine a time when they weren’t around. Store and gasoline credit cards have a long history, but the popularity of bank credit cards dates back only to the late 1960s. Today, it’s easy to get a card—either a bank, a store, or a gasoline card. Maybe it’s a little bit too easy to get a card; many people have several of them. It’s easy to make pur­chases; you just present the card. Electronic card readers collect your information and communicate with your credit card company almost instantly. Sometimes, it’s not so easy to fully pay for the purchases. And it’s incredibly easy to accrue balances on several different credit cards—balances that never seem to go away.

Gasoline and store credit cards are intended for purchases at the card issuers’ gasoline station or store. Bank credit cards on the other hand are intended for use just about anywhere.1 Most stores and gasoline stations will accept them for pur­chases even if they also issue their own cards. Bank credit cards also offer instant loans, which are called cash advances.

Tracking the calculation of your credit card interest (also called the finance charge) is not as easy as it is with a mortgage or an auto loan. You make purchases and possibly take cash advances many times each month, at random times and for differing amounts. Every month, a statement comes from the credit card company detailing all of these transactions. The monthly statement also shows a date for paying for all of your purchases without incurring any interest (the due date). If you always religiously pay your full balance on or before the due date, you do not pay any interest on your credit card purchases.

Credit cards can be a pretty good deal. Many credit cards are free. When you make a purchase using a credit card, you are actually borrowing money from a bank. You do not pay purchase interest charges if you regularly pay your bill in full before the due date shown on the statement. Interest-free loans are hard to come by. The obvious question that comes to mind then is, “Who is paying for this loan?” The answer is that the vendor of your purchase is paying for the loan. The vendor pays a fee for each purchase, usually calculated as a percentage of the amount of the purchase.

1 One of the first of these cards, issued sometime around 1969, was actually called The Everything Card. [13]

Vendors’ fees are not your problem except, of course, that these fees drive up the prices of your purchases. In a sense, this is fair. You’re paying for the conve­nience of being able to charge your purchases. The economics and marketing aspects of this belong in a business studies book, not this book. Our topic of interest (pun fully intended) is what happens when you can’t, or won’t, fully pay your bill each month. You then have to pay the interest. For the rest of this chapter, I’ll use the terms interest and finance charge interchangeably. Credit card companies seem to prefer the latter term, but I prefer the former term because it emphasizes the parallels and differences between credit card interest and other forms of debt interest.

Not fully paying your balance each month is alluring. The credit card statement shows a “minimum payment” that will keep the credit card company happy for a month. This minimum payment might be much less than the total amount of the bill. Typically, we’re all a little short of money; we’d like to go on with our lives (and continue making our purchases) as comfortably as possible, so we stare longingly at the minimum payment number and compare it to the number for fully paying for the month’s transactions (plus any remaining balance from previous months’ unpaid or incompletely paid transactions).

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