en en en en en en en en en en en en en en en en en en en en en en en en en en en en en en en en en en en en en en en en en en en en en en en en en en en en en en en en en en en en en en en en en en en en en en en en en en en en en en en en en en en en en en en en en en en en en en en en en en en en en en en en en en en en en en en en en en en en en en en en en en
People often debate the merits of one credit care versus another, as though certain cards have what even seems like a virtue at first glance! But is that really true?  Credit cards are something of a financial iceberg—the part you can see looks almost benign—and sometimes even pleasant–but the part you don’t see is where most of the costs are hiding.  And those hidden costs are buried in places we don’t often look.
Let’s take a look at the hidden cost of credit cards:
We all know about the interest we pay on credit cards—that one’s pretty easy to figure out.  But if you buy on credit and carry balances, the interest expense you pay on your credit card increases the cost of everything you buy.  Let’s say that you have a credit card that you normally carry a $5,000 balance on and that the card carries a 10% rate of interest (a pretty low number for a credit card); virtually everything you purchase will then cost 10% more, and that’s just in the first year.
Let’s say that somewhere buried in your balance is a widescreen TV set that you paid $1,000 for.  Within the first year of ownership of your TV, you’ll have paid $1,100 for the set—the $1,000 purchase price, plus 10% interest, or an extra $100.  And that’s only in the first year of buying the TV!  Interest costs will continue to increase the purchase price until the balance is paid in full.  It’s not inconceivable that the true cost of your TV will ultimately rise to $1,200, $1,300, $1,400 or more.  The discounts that you pay for purchases when you buy on sale may even be wiped out by future interest costs. [And you thought you were so smart because you researched the TV and got a deal!]
Paying interest on credit card balances is bad enough, but it’s only the beginning.  Though we tend to look at expenses in terms of visible costs, it would be better to consider all expenses in light of the question: how much income will I need to earn in order to pay this credit card expense?
Going back to our example above of having a credit card with an average balance of $5,000 and an interest rate of 10%, we can see that our annual interest cost on the card will be in the neighborhood of $500, right?  Nope!
How much income do you need to earn in order to cover $500 in interest?  If you’re in the 28% marginal tax rate on federal income taxes, 8% on FICA (roughly) and another 8% on state income taxes, or 44% in total, you’ll need to earn about $893 to cover the interest costs.  That’s pretty close to double the cost of the stated interest expense!
If you take the income tax gross-up on the income you need to pay the interest on your credit card balance each year, the effective rate is actually 17.86% ($893 divided by $5,000) — which is far higher than the 10% you think you’re paying. [And remember, 10% is a low credit card interest rate.]
Credit cards can be useful but make sure you know the hidden cost of credit cards.
Ever wonder why nearly every merchant and vendor in the known universe accepts credit cards?  Ease of customer purchase is pretty close to the top.  Merchants know that credit cards have a way of breaking down buyer resistance—even if the customer has no cash in his wallet and insufficient funds in his bank account, he can still make a purchase, if he uses a credit card!
The “little voice inside” that’s warning you that you can’t afford to buy an item is effectively silenced by a wallet full of credit cards.  That voice is one of your best defenses against overspending or going into debt, but it’s been muzzled by a piece of plastic!
Potential to play the “extension of the paycheck” game
This is very closely related to ease of purchase, but it goes one step beyond.  It raises credit cards to the level of a strategic financial tool, akin to “bargaining with the Devil” when funds are in short supply.  Credit cards are something of a personal “over and short” account, that can easily be used when expenses are over or income is short.  In not a lot of time, this can easily turn into a game that’s played to cover what you can’t afford.
It’s easy enough to see where that can lead.  I recently heard that borrowing is like reaching into the future to pull income into the present.  Some people can resist that temptation, others can’t, and if you can’t it usually doesn’t have a happy ending.  You’ve undoubtedly heard the term “two income households”?  In severe cases, there can be “three income households”, two paychecks and a monthly credit card draw.
The draw of credit card “rewards”
Finally we come to credit card rewards.  How is that a hidden cost?  Any add-on that incentivizes spending money is ultimately a cost.  Credit card companies don’t have rewards programs because they want to be nice to you; they do it because they know you’ll spend more if you’ll get a 2%, 3% or 5% reward for doing it.  So instead of buying $5,000 a year for merchandise you buy on credit, you’ll buy $10,000, or $15,000, or maybe even $20,000.  And why not—you’re being “paid” and extra two or three percent to do it, so you’re really coming out ahead, right?
Nope. Not if you’re buying more products and services than you would if you didn’t have the rewards benefit.  The credit card companies know this.  Oh, and the higher balances you’ll rack up for spending more money will also increase your interest expense—and the tax gross-up on the income you’ll need to pay it.
Remember how we talked about “reaching into the future to pull income into the present?”  When you do that you are taking your future income and committing it to your current purchases; your stuff.  But this means you can’t use this money for other things that may have more benefit long-term.  This is the opportunity cost.  The money you committed doesn’t get to be used for investing, retirement, savings, the house, car repairs, or anything else you may need money for in the future.  Buy using your credit card now, you forfeit where you can use the money later.
Never assume that interest rates alone represent the total you’ll pay for the benefit of having credit cards. There are costs you don’t see, and others in the form of increasing your spending and all the expenses that go with that.
Filed Under: Credit Cards
Glen Craig is married and the father to four children that he spends the day chasing as a stay-at-home-dad. He took an interest in personal finance when he realized most of his paycheck was going toward credit card bills. Since then he's eliminated his credit card debt and started on a journey towards financial freedom.
October 5, 2011 at 3:28 pm
You make a good argument against credit cards, however I would rather see everyone control their purchases and stay out of debt.
October 5, 2011 at 8:29 pm
I totally agree but the fact that there is so much consumer credit card debt in the country shows that people won’t just control their spending.
Sometimes people need to see what it is they are getting into when they use their credit cards.
October 6, 2011 at 12:19 am
A credit card user needs to understand the power of the tool he is possessing. If you’re not paying your credit card off in full every month you should not use the credit card. The advantages to credit cards significantly out weigh the disadvantages if you pay in full every month.
October 6, 2011 at 7:29 am
Yes, credit cards are a powerful tool! They can be powerfully enabling as well as powerfully disabling. The user needs to know what they are and the consequences of not using them wisely.
A Little About Me
I'm Glen Craig - I used to live paycheck-to-paycheck, drowning in credit card debt. I turned that all around and now I build wealth rather than debt.
My goal is to make personal finance easy for you.
Join our email list (FREE) and never miss an article!
Which Credit Card is For You?
Overall Great Credit Card Offers
0% Balance Transfer Credit Cards
0% Purchase Credit Cards
Airline Miles Credit Cards
Travel Rewards Credit Cards
Credit Cards for Excellent Credit
Small Business Credit Cards
Credit Cards for College Students
Bad Credit? Rebuild it With These Secured Credit Card Offers
The Discover it™ Card Review - An All-Around Card That's Fair to the Consumer
Citi Simplicity® Card Review - No Late Fees or Penalty Rate Hikes
Blue Sky from American Express | Review
American Express® Premier Rewards Gold Card - Review
Blue Cash Everyday ® Card from American Express Review
Gold Delta SkyMiles Credit Card from American Express Review
Starwood Preferred Guest Credit Card Review
Free From Broke is for general information or entertainment purposes only and does not constitute professional financial advice. Be smart and do your own research or contact an independent financial professional for advice regarding your specific situation.
In accordance with FTC guidelines, we state that we have a financial relationship with companies mentioned in this website. This may include receiving access to free products and services for product and service reviews and giveaways.
Think Long Term When Shopping Black Friday and Cyber Monday
10 Essential Tips For Shopping Black Friday And Cyber Monday That Will Save You Money
How to Improve Your Credit Score Fast
What is a Refund Anticipation Loan (RAL) and is it Worth It?
Paying Taxes with a Credit Card: Pros and Cons
Free From Broke is for general information or entertainment purposes only and does not constitute professional financial advice. Be smart and do your own research or contact an independent financial professional for advice regarding your specific situation.
In accordance with FTC guidelines, we state that we have a financial relationship with companies mentioned in this website. This may include receiving access to free products and services for product and service reviews and giveaways.
© 2007–2022 Free From Broke A Personal Finance Blog For Regular Folks – All rights reserved.
No content on this site may be reused in any fashion without written permission from FreeFromBroke.com | Privacy Policy | Sitemap
Copyright © 2022 · Metro Pro on Genesis Framework · WordPress · Log in
We are using cookies to give you the best experience on our website.
You can find out more about which cookies we are using or switch them off in settings.
Go to mobile version
Close GDPR Cookie Settings
Powered by  GDPR Cookie Compliance
This website uses cookies so that we can provide you with the best user experience possible. Cookie information is stored in your browser and performs functions such as recognising you when you return to our website and helping our team to understand which sections of the website you find most interesting and useful.
Strictly Necessary Cookie should be enabled at all times so that we can save your preferences for cookie settings.
Enable or Disable Cookies
If you disable this cookie, we will not be able to save your preferences. This means that every time you visit this website you will need to enable or disable cookies again.