By Joe Cowan
Financial education is the key to avoiding big mistakes which can cost you an arm and a leg, or worse, your retirement and financial security. Knowing that I had to do the research eventually I decided to take a course called “Navigating Life’s Financial Decisions” (UGBA 96) which was recommended by a few friends. While we cover various topics ranging from insurance to retirement, I was especially interested when we learned about credit and the shady practices of banks. How do people find themselves in overwhelming credit card debt and what do banks do to make it so hard to climb out of that hole?
Credit card companies make money by making spending easy. Banks know this and sometimes they come on campus to offer young (unknowing) students the dream of money right at your fingertips by advertising quick, simple steps to make an account. Uninformed people are more likely to make mistakes, leading to costly fees which banks capitalize on. Many of my peers do not even carry cash anymore and instead rely heavily on the convenience of credit cards and apps like Venmo. While it is very convenient to swipe a card and not worry about the walk to a bank or ATM, some students will fall prey to credit card debt because they do not understand or do not bother to read the fine print associated with opening their new line of credit. Here are some practices to be conscious of in order to understand how banks can charge hidden fees on your account.
The first two practices work hand in hand. The overdraft fee and the practice of reordering. Overdraft fees are incurred when you withdraw more money than you have in order to make a purchase. For example, if you had $8 in your account, but decided to buy a $40 book because you needed it for class the next day you will be charged an overdraft fee (usually around $35) for buying something which costs more than your balance.
However, some companies use a nasty trick called reordering to maximize the number of overdraft fees they can charge in a day. If constituted in the fine print of your credit card agreement, banks can shuffle the order of the purchases you made in a day. To continue with the book buying example, let’s imagine that it is the beginning of the semester. You only have $100 in your account to buy school supplies, but since you haven’t seen some of your friends for a while you decide that you can go out to lunch with them and you spend $10. You also realize you need to buy some school supplies like pencils and printer paper which cost you an additional $20. You didn’t realize you had to buy 2 books which cost $50 each for class the following day, so you decide to bite the bullet and buy the books right now so that you are prepared since you don’t mind covering the $35 overdraft fee for the convenience of having the books now. Now, if you were checking your account balance you may have stopped spending after realizing that you were spending more than you had, but let’s assume that you needed these supplies by tomorrow so you don’t mind covering the fee. However, with reordering, banks can order your purchases for the day into different categories (like those they deem most important) so that expensive purchases withdraw from your balance first. So, the banks may order your purchases so that the $100 worth of books is withdrawn from your account first leaving you with $0. The other charges—$10 for lunch and $20 for other supplies—will each be hit with a $35 overdraft fee since you have no money remaining in your balance. In the end you end up having to pay the fee twice instead of once. The bank’s reordering forces you to pay an additional $35 and your convenience to buy these books has cost you dearly.
Other common fees include the closure fee which credit card issuers impose when you close your account. Unfortunately, even when you decide to play it safe and not spend money you may be billed for an inactivity fee which activates when you don’t use your card for an allotted amount of time or you don’t reach an annual spending minimum.
With all these bills and fees adding up you may miss a payment. Guess what? A late fee is tacked onto your bill now too. The first infraction may cost around $25 and the following late periods can be charged around $35 depending on the credit card company.
To make it even better, if you make minimum payments and pay off your credit card debt slowly the high interest rate—usually 15-20%—will add up to make your purchases even more expensive. These late payments and poor credit history will affect your credit score. This can cost you thousands of dollars in the long run when you receive higher rates for other important finances such as loans and mortgages and it may even effect job and living opportunities when employers and landlords check your credit.
Credit cards sound great in theory. You get rewards or cash back for spending money you don’t even have to carry around anymore. While they are indeed useful and offer a reliable way to build up your credit score, be sure to read the fine print. You don’t want to be charged for fees you didn’t even know existed.