=Intro bookend=

Hi. 

In this lesson, we will discuss some aspects of debt and credit card use. Credit cards are a popular method of payment, but come with a number of pitfalls for the unwary. We will discuss the basic function of credit cards, talk about their costs and benefits, and model debt repayment over time.

=Learning objectives=

After this lesson, I hope you will be able to do the following:

* Describe the basic features of credit cards
* List statistics on credit card debt in the US
* Explain major types of credit card fees
* List benefits of credit cards
* Calculate monthly interest and length of time to pay off debt

and

* Describe how to use a credit card to your advantage

=Nature of credit cards=

Earlier we discussed debit cards, which are a mechanism that allows you to automatically draw on your bank account in a transaction with a merchant. A credit card is similar, in that it allows you to swipe a card to pay someone, but instead of using your own money, it allows you to automatically borrow money from the card issuer to pay for stuff.

Say you are a customer and here's a merchant. You have a credit card account at the bank. When you swipe the card to pay for stuff, the bank automatically lends you money, and passes it along to the merchant. The merchant gets the money, and gives you your stuff. Of course, at some point later, you have to repay this loan by giving money back to the bank. This is not free stuff, after all.

There is a limit to how much debt you can have outstanding on the card, of course - you can't go around charging up a million bucks. If you bump against the limit, the transaction can be either declined, or charged an extra fee.

=CC debt statistics=

Given the ease and convenience of credit card use, they are a very popular method of payment. Maybe too popular, if we look at the statistics.
The total consumer credit card debt in the US is currently about 890 billion dollars. Since there are about 120 million households in the US, that averages out to about 7000 dollars of credit card debt per household. 
About 33% of households carry credit card debt on an ongoing basis - which means that the average amount of debt among households that do carry debt is more than twice the 7000, since 7000 includes households that carry no debt within the average.
The average interest rate on credit card debt is about 15% per year - pretty chunky.

=Credit card fees=

How do credit card issuers make money? One way is certainly the interest rate that they charge on the borrowings.
Interest rates can sometimes be 0 for short promotional periods, but commonly range from about 10% to 30% or more, depending on the creditworthiness of the borrower.
In addition to the interest rate, a lot of money is made via various other fees charged to the card holder, which all stand ready to trip up the unwary credit card user.
Some cards come with annual fees. Fees range from 0, to 500 dollars per year or more. If you shop around, you should be able to find a card with no annual fee - there's rarely a good reason to be paying an annual fee.
The late fee is something that applies if you are late paying your bill. This is often in the neighborhood of 30 dollars. Don't be late.
Most credit card transactions are done to pay for something. A cash advance allows you to borrow money from the credit card and take it out in cash. This is usually a pretty expensive proposition - in addition to the interest rate that will be charged - often higher than the standard rate, you also get hit with an up front fee of 3 to 5% of transaction amount, often with a minimum of 10 dollars.
There's frequently an extra fee for international transactions of 1 to 3% of transaction amount.
Finally, the over limit fee of 25 to 35 dollars is charged if you exceed your monthly transaction limit. You can usually opt out of this feature, and just have the transaction declined if you don't have enough room in the account. 

The good news is, that you can avoid paying every single one of these costs if you are prudent in using your card. Maybe with the exception of international transaction fee, for when you are traveling, though if you know you travel a lot you could even find a card which doesn't charge this fee. 
The bad news is, just as in the case of numerous bank fees, which require vigilance to avoid, constant vigilance is required here as well. Billions of dollars of customer money is lost to these fees every year.

Finally, there's another fee, this one charged to the merchant who accepts credit card transactions. It usually ranges from 2 to 3% of transaction amount. This is the reason why you might often get a discount for paying in cash. This is also the reason why your electric company or landlord often charges a 3% extra convenience fee for credit card payments - to cover this extra cost of accepting credit as opposed to cash.

=Credit card benefits=

So with all these tricky fees, why do people use credit cards so much? Besides going into debt to pay for stuff you cannot afford - which you should avoid doing, there are a number of good reasons.
First, you can avoid having to carry cash around. This is the same benefit that you get out of debit cards, though, so not a great sales point by itself.
Second, you can get completely free money for a month, if you pay the bill in full every month. 
Third, there are significant fraud protection advantages.
Finally, there are some discounts and rewards you can get when using your card.
We will discuss all of these in more detail presently.

=CC timeline=

So, how do we get free money for a month? In fact, on average we can get free money for 1 and a half months. Let's examine the credit card billing timeline.

In the first month, you shop around and accumulate a bunch of charges. This is called the billing period. At the end of the billing period, you are issued your monthly credit card bill, listing all the transactions for that period.
However, no interest is charged on any of these purchases, until the end of the bill due date! If you pay the entire balance off at this point, you never have to pay any interest on all that money you borrewed! The time between the end of the billing period and the bill due date is called the "grace period", and is usually just about a month long, maybe 25 days, it varies by issuer.
This point is important enough to reiterate - if you pay the entire balance off by the due date, you never pay any interest on money you borrowed. This is a great deal, and it goes without saying that you should always pay off the entire balance every month.

The credit card issuer will not require you to pay off the entire balance. There is a minimum payment that they will require you to make, which usually comes out to roughly about twice the interest that would accrue, and you can also make a partial payment anywhere in between the minimum and full. But whatever you don't pay off, will start accruing interest immediately after the due date.

While the first grace period is in progress, in the meantime your next billing period is also in progress, and you can accumulate new charges. This next billing period will get its own new bill, which you again will have a grace period on, and so on. So at any given time you can have some debt outstanding, but as long as you pay off the entire bill balance by the due date every time, no interest. 

Keep an eye on those due dates, make sure never to charge more than you can afford to pay off, and you'll be doing great. 

=Fraud protection=

Now, let's talk about the fraud protection benefits of credit cards.

In the base case, if you are defrauded of cash, either by direct theft or paying cash for an item you never receive, your cash is gone. If the seller is nice enough, they could give you your money back, otherwise, you'd have to sue them in court and that's a whole drawn out process that takes time and money. So, you have not very much protection in case of fraud when using cash.

When using a debit card, things are a bit better. If someone steals your debit card and runs up a bunch of charges, at first, your money's gone from your bank account. But if you file a fraud claim with your bank, they will, after some time to investigate - a few weeks maybe, give you your money back. However, until your money comes back, your bank account is empty, your checks are bouncing, your bills are going unpaid, and you have no cash. You could be having a very bad time.

Let's see what happens when your credit card is stolen. The fraudster can run up a bunch of charges, but he is only borrowing money from the card issuer - not using your money directly. Once you file a claim with the card issuer, they will reverse the charges - usually pretty quickly, because it's their money on the line after all. You come out of this in one piece with no harm done. So the credit card is like a wall between the thief and your money, keeping it safe.

This level of fraud protection makes a credit card a pretty good deal.

=Rewards=

Now let's discuss card rewards. 

Often a credit card will have a rewards program, wherein you will get about 1 or 2% cash back on stuff you pay for with your card. Sometimes it'll actually accumulate as cash back that you can apply to your billing statement, other times it'll accumulate as 'reward points' which end up being worth about 1 cent on the dollar and you can then redeem for statement credits and other stuff. At the end of the day, as long as you are diligent about not paying any fees, this is like a free discount on everything you buy with your credit card. Nice.

Since the card issuer charges the merchant 3%, they think they can afford to give away 1% to the users to entice greater volume of transactions.

Rewards come in many shapes, though. Some have rotating bonus categories, or give you travel discounts or airline miles and so on. Depending on your lifestyle, some of these might give you greater bang per buck than a straight up 1% cash back. 
Personally, I stick with the plain cash back, as I view the funky rewards as underhanded attempts to influence the card user's spending. "Ooh, they have 3% cash back on restaurants this month, I guess I should eat out more" or "Ooh, my hotel discount points are expiring, I guess I should go take a vacation before they do". No thanks, just give me my cash back on everything and stop with the tricks.

At the end of the day though, the main thing is to be cognizant of and avoid the fees. The rewards are pretty negligible compared to that, so don't go out of your way just for the rewards.

=Quiz 1=

For instance, let's say you spend quite a bit per year on your card, 10 thousand dollars, and the card gives you 1% cash back. How much are you saving per year? Give it a thought. 

If you calculate it out - you only get an extra 100 bucks per year. 100 bucks is nice, of course, but 100 bucks over the course of the entire year, is really nothing to write home about.

=Example: debt repayment=

Now, let's look at an example of credit card debt repayment. Let's try to see just what is the cost of the average household debt of 7 thousand, if you pay the average rate of 15% and make a minimum payment of $150 per month. How long will it take? How much in interest do you end up paying? Let's model this in a spreadsheet.

One note about rates, first. Rates are stated as APR, annual percent rate, which meants that the rate per month is just 1/12th of the APR, rate per quarter is 1/4th of the APR, and so on. Since credit card billing cycle is monthly, we will be dealing with the monthly rate, which is 1/12th of the annual stated rate.

First, let's create a timeline.
Then, let's put in our constants over here on the side.
Principal, payment amount, annual rate. The monthly rate is 1/12th of the annual, which comes out to 1.25 percent.

In the second column, let's track the outstanding principal.
So, at time 0, we start with 7000 dollars of carried debt. During the month, we will accrue 1.25% of that in interest - the monthly interest rate. This comes out to 87.5. 
We will make a payment of 150, and our end of month balance is initial balance, plus accrued interest, minus payment. This comes out to 6937. 

The next month's interest is going to again be 1.25% of starting principal, but before we fill down, let's lock in the rate reference. Our payment will be exactly the same, 150, so let's lock in that reference also.

Drag this down once more. Looks reasonable. We are slowly eroding the principal of the debt outstanding.

To find out how long it'll take, let's keep filling down until the principal hits 0. 

Looks like after 71 months, we'll finish paying it off, with a last payment of 71 bucks and a bit. That's just under 6 years!

In the meantime, how much have we paid in interest? if we add up the interest column, using the sum function, our answer is revealed as 3571. So in addition to the 7000 of original debt principal, we paid an extra 3500 some bucks in interest - over 50% of the principal. This was an expensive piece of debt. 

Moral of the story? Don't carry credit card debt. 

=Quiz 2=

What happens if we kick in an extra 50 bucks a month toward repaying this debt, paying a total of 200, rather than the minimum payment of 150? 
How soon will you finish paying it off?
How much interest will you have paid by the time you are done?

Take a few moments and play around with the spreadsheet - it is available for download right next to the video. Tweak the payment amount, and observe what happens. Take your time, I'll wait.

Let's change the payment to 200, and scroll down to see when our principal drops through 0. Looks like we are done after 46 months. 
All these negative amounts don't actually happen, so let's delete them, and observe our interest sum. 2200 bucks or so.

So, by kicking in a little bit extra every month, we have reduced the time required to pay off the debt from about 6 years to about 4 years, and saved about 1300 bucks in interest in the process. Not too shabby!

You don't want to ever have a bunch of carried credit card debt. But if it so happens that you do, increasing your monthly payment by even a little bit can speed up repayment significantly and save you a bunch of money in the process.

=Being smart about credit cards=

So, let's sum up what we learned.

Do not pay fees or interest - it is possible to use credit cards without any fees. You just need to be aware of the fees and be vigilant about paying off your entire balance every month and on time.
Enjoy the fraud protection. If you don't get a discount for using cash, or if you're not sure of the trustworthiness of the merchant, there's no reason not to use a card for that extra bit of protection.
Finally, reap your cash rewards. They are nothing to write home about, but a free discount is a free discount.


=Additional reading=

Credit cards are widely used, but they are also commonly used unwisely. I hope with this lesson, you are armed with the necessary knowledge to take advantage of the benefits of credit cards while avoiding the traps set out by the credit card issuers.

If you want to know more, searching the web for something like "smart credit card use" will give you a wealth of tips and other information.

Thank you for your attention.

=Attributions=