U.S. PIRG Consumer Blog: Credit card penalty fees skyrocket, so do calls on Rewards

Jane Kim had a good piece on 11 Aug called Credit Card Penalties Hit New Highs in the Wall Street Journal (subscription required) last week on rising credit card income, especially from penalties: she reports Cardweb calculates that penalty income went from $12 billion in 2003 to $15 billion in 2004. She cites new data from Consumer Action's latest report: "Already, rates for late payments have risen to an average of 24.23% from 21.91% last year, according to a survey released last month by the consumer-advocacy group Consumer Action." But that's not what I am really writing on today. Today I am writing on Rewards cards.

For some reason, I am getting a lot of calls from reporters asking about my recommendations on "Rewards" credit cards. Well, my views are quite simple -- if you carry a credit card balance, it doesn't matter. You lose. I just googled "rewards" cards and came up with a bunch of sites. Here's an example from one meta-site that says this applies to a Chase Cash Plus Rewards Visa. I didn't compare or double check on the bank site, but it is a typical offer-- Earn "5% cash back at grocery stores, gas stations and drug stores" and earn "1% cash back on all other purchases."

This card is encouraging you to use your card to get its biggest cash-back offers for what are likely to be small purchases and, worse, what are likely to be regular daily expenses. If you are a consumer who carries a credit card balance, especially one who pays a penalty interest rate, you definitely lose. You shouldn't ever use a credit card for daily necessities and regular purchases if you carry a balance on the card.

Oh, what if you are a smart consumer and manipulate a series of cards with balance transfers at zero percent interest rates and switch cards when the zero percent offers expire? Well, a few of you may win this way, but especially in the long run, most of you will lose. The percentage always goes to the house.

Say your spending pattern means you get the full 5% rewards on this card, and you just spent $100, but you already had a balance of $1,000 (pre-rewards). Say your interest rate was just raised to 30% APR because you were late just once. A 30% annual APR means simple interest accumulates on your balance at the rate of 2.5% each month (30/12). That means the $5.00 in "rewards" offsets your first month's interest on the $100 and you net $2.50. But if you add the $100 to your $1,000 balance and keep making minimum payments, you keep accumulating about $2.50/interest each month on the $100 (and another $25 on the other balance) for a year while you make the minimum payment on the $1,100. You may not pay off that balance for years and years and years. We do the math on minimum payments at our website www.truthaboutcredit.org, especially on this page.

It is really quite simple. If minimum payments are about equal to monthly interest rates -- which they are at 30% APR, you are not only not paying down your balance, you are likely going even further into debt (called negative amortization). At 15% APR, and still making only minimum payments, you are better off, of course, but not well off. Anyone who carries a balance -- even if they sometimes pay more than the minimum -- should think about paying down the balance and not think about rewards. The bank wants you to forget about interest and think about rewards. Bad idea.

If you are a convenience user who pays off your cards monthly, figure out your own favorite rewards cards. The rest of you--figure out how to make bigger monthly payments and be sure to make them on time to avoid penalty interest rates and penalty fees. Your biggest and best reward-- getting out of credit card debt.