David Lerner Associates: Credit Traps for the Unwary

It's hard to imagine functioning in today's society without access to credit. However, one has to be careful not to fall victim to some of the pitfalls associated with it.

Revolving credit can make it hard to pay off debt

Credit cards make it easy to spend money now and repay the amount over time instead of all at once. Every time the card is used, the balance owed increases, and the remaining available credit decreases. As payments are made, the outstanding balance reduces and the available credit once again increases. This is called revolving credit.

Since credit makes it possible to spend more than one currently has, it’s easy to spend more than one can afford. As the balance increases, so does the minimum monthly payment. If one is not careful, this can quickly get out of hand, especially if interest rates and other fees are high.

Interest and fees can add to the cost

Credit card debt generally carries a high interest rate. The minimum monthly payment–a percentage (often as low as 2 to 4 percent) of the total balance due–may cover little more than the monthly interest charge. Consequently, that minimum payment may only minimally decrease what’s owed. If possible, increase the monthly payment above the minimum required. The higher you can make the payment, the faster the debt gets paid off.

When opening a new account, always check to see how the finance charge is calculated. Here are some of the methods used:

• Adjusted balance method: Balance due at the beginning of the billing cycle less any payments made during the cycle; excludes new purchases made during the cycle
• Previous balance method: Balance due at the beginning of the billing cycle
• Average daily balance method: Total of the balances due each day in the billing cycle divided by the number of days in the cycle; payments made are subtracted as posted to determine daily balances; new purchases may or may not be added in

The finance charges can vary widely from method to method.

In an effort to attract new business, many lenders offer very low introductory rates–3.9 percent annually or less. However, these rates generally last no more than three to six months and increase to the current market rate thereafter. Moreover, the introductory rates may apply only to balances transferred from other cards. They may not apply to new purchases and rarely, if ever, to cash advances. Finally, if the monthly payment is late, the interest rate may be raised to the current market rate–and sometimes beyond.

A credit card issuer may increase the interest rate charged under specific circumstances. These circumstances are:

(1) The index on which the rate is based changes

(2) It is a promotional rate that has expired

(3) The account holder has failed to comply with a hardship workout plan

(4) The account falls 60 days past due

If the rate is increased because the account falls 60 days past due, the card holder must be informed that the rate increase will be terminated (and the rate restored to what it was before the increase) once you have made timely minimum payments for six months. However, in this case, it's doubtful the rate would be restored to the original low introductory rate.

Surfing debt – beware the wake

It is possible to transfer a credit card balance from one introductory offer to the next. This is known as surfing. Done successfully, this avoids the higher interest charges that the debt would incur when the original card offer expires. By the time the interest rate on the original card increases, it’s been surfed over to a new offer at another low rate.

Although surfing helps keep interest charges to a minimum, it's not without pitfalls. If the low rate is only on balance transfers, new purchases and cash advances are billed at a higher interest, and these charges could offset any savings on the transfer.

Moreover, as creditors move to counteract the surfing trend, many stipulate that if the balance is transferred to another card within a certain time after opening your account, there will be retroactive charges at higher rate of interest on the amount transferred. Thus, surfing before this time period is up eliminates the savings.

Once the balance has been transferred, close that account. Write the creditor a letter (keep a copy) asking it to inform the credit bureaus that the account was closed at the cardholder’s request. This prevents new potential creditors from denying credit when they see too many open lines of credit, and it also deters anyone else from fraudulently using an inactive account.

IMPORTANT DISCLOSURES
Material contained in this article is provided for information purposes only and is not intended to be used in connection with the evaluation of any investments offered by David Lerner Associates, Inc. This material does not constitute an offer or recommendation to buy or sell securities and should not be considered in connection with the purchase or sale of securities.

David Lerner Associates does not provide tax or legal advice. The information presented here is not specific to any individual's personal circumstances. Member FINRA & SIPC.

To the extent that this material concerns tax matters, it is not intended or written to be used, and cannot be used, by a taxpayer for the purpose of avoiding penalties that may be imposed by law.

Each taxpayer should seek independent advice from a tax professional based on his or her individual circumstances.

These materials are provided for general information and educational purposes based upon publicly available information from sources believed to be reliable– we cannot assure the accuracy or completeness of these materials. The information in these materials may change at any time and without notice.

Some of this material has been provided by Broadridge Investor Communications Solutions, Inc.