Ch. 20:  Credit Cards

20.0 Introduction

            Credit cards are useful, but dangerous tools.  At best, they allow consumers to borrow money, pay it back next month, and generate returns from delayed repayment and cash back rewards.  At worst, they can derail your finances and ruin your life.  This chapter is not to be taken lightly.

20.1 Selecting and Applying for a Card

            In Chapter 19, we learned that attaining a credit card is a good way to start and maintain one’s credit score.  How exactly should you go about doing that?  First and foremost, I would encourage you to avoid being a sucker.  As you get more financially secure and establish a credit history, it’s likely that you will receive a barrage of credit card offers in the mail and from retailers… No I don’t want a freaking T.J. Maxx credit card to save 10% on my purchase today, thank you very much.  Don’t choose your card based on how aggressively you were targeted by marketers.

            Rather, you should seek out credit cards that fit your needs.  Remember, your first credit card should have no annual fee so that you may keep it your entire life free of charge.  Thus, the first card you get should probably be one with simple features and generalizable uses.

A Good First Card

            A popular credit card among college students is the Discover it Student Cash Back Credit Card, shown here:

This card is popular for a reason.  It offers a nice cashback benefit and no annual fee.  Users of this card will earn a 1% cash back benefit on most spending but can unlock 5% in certain spending categories during the year.  From January to March, the spending category was restaurants… this was quite useful for me.[1]  After your first year of card ownership, your first-year cashback earnings are automatically doubled making this a truly great card to use in year 1.  Unfortunately, this is just a first-year promotion; following year 1, the cashback is solid but nothing special.  So, if you really want to take advantage of cashback rewards, you might consider some other cards.  For travel redemptions, here are some good options.

            Credit cards are not for everyone, but if used properly, can generate significant value to the user.  In this chapter, I’ll discuss the potential benefits of credit cards and close with a word of caution.

20.2 Using a Credit Card

            Nowadays, what with the internet and all, most purchases are made using a debit or credit card.  While these cards have a similar physical appearance, there is a substantial difference in how these transactions differ.  When you spend money using a debit card, you are not borrowing.  Rather, each debit card transaction triggers a withdrawal from your account.  While there is a small delay between your purchase and a withdrawal from your checking account, debit card spending approximates spending with cash.[2]

            With a credit card, however, the buyer is explicitly a borrower.  A $100 purchase using a credit card does not automatically lead to a withdrawal from your checking account and the buyer has the option to delay repayment.  For many, this is a dangerous proposition.  The human mind has a tendency for myopia—to overvalue the short-run and pay little mind to the long-run.  This shortsightedness causes otherwise careful consumers to spend more than they can afford, triggering a lifelong relationship with credit card debt.  And this is an abusive relationship.  Credit card interest rates usually exceed 20% and compound daily. 

            Unsurprisingly, credit cards get a bad rap.  Financial gurus like Dave Ramsey urge followers to completely avoid credit cards since the risk they pose is so enormous.  I admit, I sympathize with Dave here.  On a national level, I suspect credit cards have done more harm than good.  But, for the savvy and responsible, credit cards offer significant benefits that shouldn’t be ignored.  From my experience as a college professor, just about all my students have a credit card.  So, I’m not going to play the “should you or shouldn’t you have a card” game.  That game is pointless.  You probably already have a credit card, so let’s make sure you know how to use your card correctly.

            Once you receive your Discover it Student card (or any other no annual fee credit card) and activate[3] it, you may immediately make purchases.  These purchases will be funded by the associated lender (usually a bank), like Chase, Wells Fargo, Discover, etc.  After that first purchase, you are now in debt.  But there’s nothing to fear (yet)!  If you pay off your credit card purchases within a prescribed window, no interest will be charged.  To better understand the math and language used by credit card issuers, consider the current standing for a fictional credit card user:

            Current Balance:  $812.62

            Last Statement Balance:  $502.18

            Minimum Payment:  $100.00

            Payment Due Date:  August 22, 2024

As a credit card user, it is imperative that you fully understand the meaning of the above information.  And I’ve learned that many college students do not. 

            The value that is of most pressing importance is “last statement balance”.  This figure ($502.18) shows how much the credit card user needs to pay by the payment due date to completely avoid interest charges.  This value is based on purchases made by the credit card user during the previous statement window; as a credit card user, the statement that you are paying now is, roughly, based on the purchases made last month. 

           This is not to be confused with the current balance, which shows how much money you have borrowed (and thusly owe) in total at present.  This credit card user currently owes their credit card issuer $812.62.  But not all of that money is due on August 22nd.  Only $502.18 should be paid by this due date, the remaining balance ($310.44) will be applied to next month’s statement, due September 22, 2024.  To clarify, the current balance counts all money borrowed by the credit card user.  This includes the last statement balance in addition to spending that has accrued in the current statement period.

           What about the minimum payment?  Some consumers mistakenly believe that this is the minimum spending required to avoid interest.  That is so very wrong.  The minimum payment is merely the minimum payment this person can make (by August 22nd) to avoid late fees and keep their account in good standing.  If they only pay $100, they will be charged interest on the remaining $402.18 in unpaid statement balance.  Choosing to pay this minimum amount is a good way to sabotage your finances.

            As a case study, consider my most frequently used credit card, a Chase Sapphire Preferred.  As of today, here is my situation:

In total, I have $2,297.87 in unpaid borrowing on my card.  I need to pay at least $1,818.67 to avoid interest on my card.  The remaining balance ($479.20) will be applied to next month’s statement balance.  I could choose to pay the minimum amount ($40.00) but doing so would result in significant interest charges.  To maximize the value of a credit card and to avoid interest, I always choose to pay the full last statement balance each month… but not a penny more. 

           In addition to these essential values, a few other key details are provided about my situation.  I have $22,315.13 in available credit—this is the maximum amount of money I could spend (i.e. borrow) with my credit card, at present.  I have automatic payments turned on, so that my statement balance is automatically paid via my checking account on June 1, 2024.  In doing so, I don’t need to worry about forgetting to make a payment, but I will need to ensure that my checking account has adequate funds to cover the $1,818.67 withdrawal that will automatically occur on June 1st.  Finally, my account shows Ultimate Rewards balance of 11,722.  These are points that I earn for purchases made on my card, which can be redeemed for travel.  You can learn more about this card and others here.

20.3  Generating Value from the Payment Float

          By electing to pay the statement balance only, the credit card user can take full advantage of what is, effectively, a zero-percent interest rate loan.  Think about it… when you pay $40 for a meal in July using a credit card, you are not required to spend your money until August.  One month is not a long time, but over the course of your life, the benefits of deferring payment by one month leads a surprisingly large lifetime benefit. 

          To explore this concept, let’s create two (admittedly) unrealistic scenarios.  Olivia and Oscar both spend $4,000 every month.  Olivia always uses cash, while Oscar gets a credit card at the beginning of January and uses it for exactly one year. To keep things simple, let’s assume they die at the very end of this year, lol.  Beginning with Olivia, consider the table below.

Each month, Olivia spends $4,000 and her purchases immediately match with her cost.  When she buys a $60 meal, she pays $60 immediately using her own money.  This isn’t very interesting, is it?  But Olivia’s cash-only spending method gives us something to compare against.  Now, let’s look at Oscar who always uses a credit card and only pays off the last statement balance every month.

In January, Oscar has a “free” month.  With his new credit card in hand, all purchases made on the card in January are effectively pushed-back one month.  When he pays $60 for a meal in January, he doesn’t feel the direct cost of the meal until February, when he pays his statement balance for the previous month’s spending.  In February, he pays for January’s purchases, in March, he pays off February’s purchases, and so forth.  Unlike Olivia, Oscar is left with one additional payment at the end of the year.  In January of next year, he will still need to pay for December’s purchases. 

            Once the dust settles, it’s easy to make a comparison between Olivia (cash) and Oscar (credit card).  The only differences in their spending occur in January this year (when Oscar is using the card for the first time) and January next year (when Oscar is paying off his final month statement balance for December).  If Oscar does not do any investing, these two scenarios are equivalent.  But if he invests, he can realize some important gains.

            Suppose Oscar invests the “freed-up” $4,000 at the beginning of this year; in other words, he takes the $4,000 that he didn’t have to spend in January of this year and invests it in stocks.  If he earns a 10% interest rate, he will have turned his $4,000 into $4,400 by January of next year.  He can then take the $4,000 to pay his final statement balance (postmortem) in January of next year and will be left with $400 in profit that was generated solely by taking advantage of the so-called payment float.        

            That’s not much money in the scheme of things, but let’s consider a longer time horizon—a full lifetime.  Imagine Oscar gets a credit card in January of this year, when he is 25 years old.  He uses it for all purchases from 25 until his death 60 years later.  What would this look like?  For simplicity, let’s again assume that he spends $4,000/mo throughout his lifetime.

By paying off his statement balance every month, Oscar can effectively borrow $4,000 interest-free this year and invest this $4,000 for 60 years.  How much money would he have after 60 year’s of investing?  Using a 10% annual return, let’s see the math:

FV = $4,000(1 + 0.1))60 = $1,217,927

Whoa!  Be careful, that’s not the final answer.  In January (right after death), he will still need to pay $4,000 to cover his final Credit Card statement balance, so the payment float benefit is “only” $1,213,929.

            Admittedly, this is an overstatement of the benefits of the payment float.  Over time, one’s spending usually rises due to, if nothing else, inflation.  This will reduce some of the “profit” gained.  Furthermore, if a person’s net worth is much higher due to the payment float, we might expect them to ramp-up their spending even more as they age.  Regardless of the specifics, the benefits of the payment float are shockingly large and, for me, impossible to ignore.  So, I take full advantage.  In practice, taking advantage of the payment float is a breeze.  Here is all you need to do:

Maximizing the Benefit of a Payment Float

1.       Find a good credit card with no/low annual fee.

2.       Use a credit card for all purchases, when permitted. 

a.       Credit cards are difficult to use for paying rent, but a Bilt credit card makes it possible.  Monthly mortgage costs are even more difficult (impossible?) to pay with a credit card.  Most other purchases allow credit card payment.

3.       Pay the last statement balance each month. 

a.       Do not pay less since you are charged interest on the unpaid balance.

b.       Do not pay more, as you will miss out on the full value of the payment float if you do.

4.       Invest as much as you can all the time.

a.       If you always invest as much as possible, you will automatically invest the money that is made available using a credit card.  Keep in mind that you don’t need to take on unnecessary risk.  You can invest in bonds, a high-yield savings account, or other safe assets and still generate a payment float benefit.

20.3  Credit Card Rewards and Perks

•            In addition to generating value from payment floats, a credit card user can prioritize a card that offers cash-back rewards or other benefits.  Many cards, such as the aforementioned Discover it Student card offer cash back rewards on all purchases.  The specifics regarding these rewards vary drastically from card to card.  Since many cards offer larger cash back rewards for certain spending categories (often for dining out and travel expenses), it can be beneficial to possess multiple cards.  For example, I use an Amazon Prime Visa (link) for all purchases made on Amazon.com, generating a 5% cash back reward.  But, since this card only generates 1% cash back on other purchases, I use other cards for most purchases.  By using multiple cards, I’m able to generate at least 2% cash back on all credit card purchases, meaningfully reducing my cost of living.  

          Many credit cards also provide users with a minimum spend bonus, which provides new cardholders with a valuable incentive at the onset of card ownership.  For example, consider this credit card:

The Wells Fargo Active Cash Card is a great card!  In addition to 2% cash back on all spending, new users earn a $200 bonus after spending $500 in the first three months of card ownership.  With no annual fee, I’d consider this a strong contender for the best first card for young folks looking to start their credit history. 

20.5 Credit Cards and Spending

  I’m hesitant to promote these minimum spend bonuses too aggressively.  Attaining $500 in spending is a non-issue for most, but many cards have much higher thresholds.  I suspect there are many new credit card users that over-spend simply to unlock a minimum spend bonus; in doing so, the potential benefits of a new card are more than offset.[4]  Furthermore, many of the most lucrative minimum spend offers are attached to cards with high annual fees.  The Platinum Card by American Express offers a monstrous 150,000 points (worth at least $1,500) for users that spend at least $8,000 over the first six months of credit card ownership.  But the card comes with a $695 annual fee.  An unsavvy user will get this card, increase their spending to unlock the benefits, and then keep the card for years, paying $695 each anniversary.  Don’t be that person.

            In addition to cash back rewards and minimum spend bonuses, some cards offer a litany of additional perks.  A few of my cards provide free insurance for rental cards, while others include free cell phone insurance plans.  Navigating these benefits is exhausting (or fun, if you’re a weirdo like me).  Plan to do a lot of research if you hope to maximize your benefits.

            For many, the most lucrative credit card rewards are connected to travel programs.  In the summer of 2024, my family of four flew to Hawaii and back for free using points generated by a Southwest Credit Card.  Such lucrative travel rewards are not an anomaly for us; I generate about $3,000/year in free travel (usually flights and hotel stays) through credit card rewards.  But I’m not saving money by using these cards.  My “free” travel benefits lure me to expensive cities where I spend a king’s ransom on experiences and costly meals.  To me, it’s worth it.  I love traveling.  But in the wrong hands, the drive to generate travel rewards can strangle one’s finances.  I offer some travel credit card suggestions here, but I hope you will think carefully before you consider playing the travel rewards game.

20.6 A Final Caution

            From a mathematical perspective, the potential utility of a credit card is obvious.  Through cash back rewards, minimum spend bonuses, and payment float benefits, credit card users should be able to generate five to six-figures worth of extra cash throughout their lives.  Optimal use of credit cards can lead to an early retirement!  But I suspect such optimal usage is extremely rare.

            Prior academic research convincingly shows that consumers spend more money when they switch from cash (or debit cards) to credit cards.  While I won’t bore you with the details, it’s vital that you understand the general finding of researchers:  By switching from cash to credit card, you may be inadvertently choosing to spend more money, reducing your savings rate, and pushing-back your retirement date.  Earning 2% cash back is of little benefit if you spend 20% more money as a result of a new credit card.

            As of early 2024, US consumers had more than $1.1 Billion in credit card debt (or about $3,000 per citizen).  With interest rates on this debt typically exceeding 20%, credit card debt is akin to financial suicide.  So, I urge you to be careful with your credit cards and I support those that choose to avoid using credit cards altogether.  Credit cards are useful, but unessential. 

End Notes

[1] The maximum cash-back is $75 for each 5% category (which converts to $150 in your first year).  So, you could spend up to $1,500 at restaurants with the 5% promotion enabled. 

[2] This is true from the spender’s perspective.  From the merchant, it’s not.  When you buy a $5 coffee from Starbucks, using cash, Starbucks earns $5 in revenue.  When you use a debit card, the merchant pays various fees related to the processing of the transaction, which shrinks a $5 purchase into about $4.75 in revenues.  Similar fees apply for credit cards.  For business owners, this is important.  For people like you and me, who don’t own a business, there’s not much reason to care about these fees.

[3] When you receive your card, you will be given instructions to activate your card.  This usually entails making a phone call and/or following a weblink to prove you are the rightful owner of the card. 

[4] If you’re academically minded, you might enjoy my paper on the subject, coauthored with a former student of mine, Noah MacDonald.  You can find the paper here.

Key Terms

Annual Fee:  Many credit cards charge annual fees simply for the privilege of using the card and enjoy its benefits.  I recommend that your first credit card has no annual fee.

Cash Back Rewards:  Many credit cards offer a kick-back to consumers as an incentive to use their card.  A 2% cash back card, for example, effectively makes purchases 2% cheaper for the credit card user relative to someone using a debit card or cash.

Credit Card:  Financial tool that allows users to pay for goods and services with borrowed money.

Current Balance:  The total amount of borrowed money currently amassed on your credit card.  Of this amount, only the last statement balance must be paid by the payment due date.

Debit Card:  Financial tool that allows users to pay for goods and services.  Like a credit card, but without the borrowing since purchases made with a debit card are made with money in your checking account.

Last Statement Balance:  Total dollar-amount that must be paid by the payment due date to avoid interest charges.  The last statement balance is total amount of money you spent on your credit card during the last statement (typically in the previous month).  You are required to pay this money back soon, but charges on the current statement are not due until next month.

Minimum Payment:  The minimum payment required (by the payment due date) to avoid a late charge and to maintain good standing with your credit card issuer.  If you only pay the minimum payment, you will be charged interest on the remaining unpaid portion of your last statement balance.

Minimum Spend Bonus:  Many credit card issuers offer an initial spending incentive to lure customers. For example, a card might offer a $500 cash back reward for new customers that spend at least $5,000 on the card in the first three months of ownership.  The potential benefit of such a reward is obvious, but some consumers increase their spending to unlock the benefit, which results in a reduction in savings.

Payment Due Date:  Date at which you must pay the last statement balance to avoid interest charges. 

Payment Float:  A potential credit card benefit that results from a user paying only the last statement balance each month, which allows the user to invest extra money compared to someone that uses cash or a debit card for purchases.  This is a tough subject.  Make sure you read the section in this chapter.

Practice Problems

1. Suppose that Amy gets a credit card in November, 2025.  She spends $5,000 every month on the card, just as she had done with cash and always pays her statement balance in full.  She closes the card in October 2035 and makes her final payment in November 2035 (exactly ten years after her first usage of the card). 

a.       Explain the “payment float” and why this is beneficial for Amy.

b.       If she is able to earn 9% compounded annually in the stock market, how much money can she save by using this credit card instead of cash?

2. Suppose that Milly gets a credit card in November, 2025.  She spends $1,500 every month on the card, just as she had done with cash and always pays her statement balance in full.  She closes the card in October 2050 and makes her final payment in November 2051.  If she earns 10.2% compounded annually in the stock market, how much money can she save by using this credit card instead of cash?

3. Suppose that Lucy gets a credit card in November, 2025.  She spends $6,500 every month on the card, just as she had done with cash and always pays her statement balance in full.  She closes the card in November 2026 and makes her final payment in December 2026.  If she can earn 8.8% compounded annually in the stock market, how much money can she save by using this credit card instead of cash?

4. I get a new credit card that offers a $500 minimum spend bonus if I spend $1,000 total in the first three months.  In addition, the card offers 2% cash-back on all purchases. If I spend $2,000 every month, how much money will I save in a year (considering only the MSB and cash-back rewards) using this card instead of cash?  (for simplicity, assume that any savings are held in a bank account earning 0% interest)

5. I get a new credit card that offers a $500 minimum spend bonus if I spend $3,000 total in the first three months.  In addition, the card offers 2% cash-back on all purchases. If I spend $2,000 every month, how much money will I save in a year (considering only the MSB and cash-back rewards) using this card instead of cash?  (for simplicity, assume that any savings are held in a bank account earning 0% interest)

6. I get a new credit card that offers a $200 minimum spend bonus if I spend $2,000 total in the first two months.  In addition, the card offers 1% cash-back on all purchases. If I spend $2,000 every month, how much money will I save in a year (considering only the MSB and cash-back rewards) using this card instead of cash?  (for simplicity, assume that any savings are held in a bank account earning 0% interest)

7. I get a new credit card that offers a $500 minimum spend bonus if I spend $10,000 total in the first three months.  In addition, the card offers 1.5% cash-back on all purchases. If I spend $2,000 every month, how much money will I save in a year (considering only the MSB and cash-back rewards) using this card instead of cash?  (for simplicity, assume that any savings are held in a bank account earning 0% interest)

8. You have $14,000 in credit card debt on a card that charges 17.99% interest, compounding 365 times per year.  If you make no payments, how much will you owe in 10 years?

9. You have $25,000 in credit card debt on a card that charges 26.49% interest, compounding 360 times per year.  If you make no payments, how much will you owe in 8 years?

10. You open your credit card account online.  You find that you have a $3,600 current balance, a $2,100 statement balance, and a minimum required payment of $100.  Assume that each payment is made “on time”.

a.       Explain what will happen if you pay $100.

b.       Explain what will happen if you pay $2,100

c.       Explain what will happen if you pay $3,600

d.       Explain what will happen if you pay $1,000

e.       Explain what will happen if you pay 2,500

11. Based on what you’ve learned, do you think that personal finance experts or members of the general public will benefit more from using credit cards?  Explain.

12.  Explain why it’s advisable to choose a no annual fee credit card as your first card.

13. What interest rate do debit card companies charge if I only pay the minimum payment on my debit card account balance?

Practice Problems

Solutions

1. Suppose that Amy gets a credit card in November, 2025.  She spends $5,000 every month on the card, just as she had done with cash and always pays her statement balance in full.  She closes the card in October 2035 and makes her final payment in November 2035 (exactly ten years after her first usage of the card). 

a.       Explain the “payment float” and why this is beneficial for Amy.

Amy effectively “pushes” back every purchase by one month. Her initial $5,000 spent in November will be paid in December.  Her December payment will be paid in January.  And so forth.  Considering all purchases, relative to cash, Amy will spend $5,000 less in November 2020 and $5,000 more in November 2030.  To take advantage, she can invest the $5,000 savings from November 2020.  To determine how much she saves in total, we will need to determine how much her investment is worth in November 2030 after she pays off the remaining $3,000 payment.

b.      If she is able to earn 9% compounded annually in the stock market, how much money can she save by using this credit card instead of cash?

FV = 5,000(1.09)10 = $11,836.82

(note that this is not the final answer.  Relative to using cash, usage of the credit card reduces her spending by $5,000 in November 2020, but it adds $5,000 in spending in November 2030.  So to figure out how much the card saves her, we need to subtract off the $5,000 that she will need to spend in November 2030.

Money saved = $11,836.82 - $5,000 = $6,836.82

2. Suppose that Milly gets a credit card in November, 2025.  She spends $1,500 every month on the card, just as she had done with cash and always pays her statement balance in full.  She closes the card in October 2050 and makes her final payment in November 2051.  If she earns 10.2% compounded annually in the stock market, how much money can she save by using this credit card instead of cash?

FV of initial money saved = 1,500(1.102)25 = $17,007.13

Money saved = $17,007.13 - $1,500 = $15,507.13

3. Suppose that Lucy gets a credit card in November, 2025.  She spends $6,500 every month on the card, just as she had done with cash and always pays her statement balance in full.  She closes the card in November 2026 and makes her final payment in December 2026.  If she can earn 8.8% compounded annually in the stock market, how much money can she save by using this credit card instead of cash?

This is 13 months of credit card use.  So, n = (13/12)

FV of initial money saved = $6500(1.088)(13/12) = $7,121.88

Money saved = $7,121.88 – $6,500 = $621.88

4. I get a new credit card that offers a $500 minimum spend bonus if I spend $1,000 total in the first three months.  In addition, the card offers 2% cash-back on all purchases. If I spend $2,000 every month, how much money will I save in a year (considering only the MSB and cash-back rewards) using this card instead of cash?  (for simplicity, assume that any savings are held in a bank account earning 0% interest)

Savings from MSB = $500

Savings from cash-back = $24,000*0.02 = $480

Total savings = $980

5. I get a new credit card that offers a $500 minimum spend bonus if I spend $3,000 total in the first three months.  In addition, the card offers 2% cash-back on all purchases. If I spend $2,000 every month, how much money will I save in a year (considering only the MSB and cash-back rewards) using this card instead of cash?  (for simplicity, assume that any savings are held in a bank account earning 0% interest)

Same as question 4!  The MSB has a different spending threshold, but that doesn’t matter given my spending amounts.

Savings from MSB = $500

Savings from cash-back = $24,000*0.02 = $480

Total savings = $980

6. I get a new credit card that offers a $200 minimum spend bonus if I spend $2,000 total in the first two months.  In addition, the card offers 1% cash-back on all purchases. If I spend $2,000 every month, how much money will I save in a year (considering only the MSB and cash-back rewards) using this card instead of cash?  (for simplicity, assume that any savings are held in a bank account earning 0% interest)

Savings from MSB = $200

Savings from cash-back = $24,000*0.01 = $240

Total savings = $440

7. I get a new credit card that offers a $500 minimum spend bonus if I spend $10,000 total in the first three months.  In addition, the card offers 1.5% cash-back on all purchases. If I spend $2,000 every month, how much money will I save in a year (considering only the MSB and cash-back rewards) using this card instead of cash?  (for simplicity, assume that any savings are held in a bank account earning 0% interest)

Savings from MSB = $0.  (I didn’t spend enough to reach the spending threshold)

Savings from 1.5% cash-back = $24,000*0.015 = $360

Total savings = $360

8. You have $14,000 in credit card debt on a card that charges 17.99% interest, compounding 365 times per year.  If you make no payments, how much will you owe in 10 years?

FV = 14,000(1 + 0.1799/365)365*10 = $84,572.92

***Your actual debt would be greater than this is you actually made no payments.  You would be charged late fees every month for missed payments.  Truthfully, you would probably be sent to a collection agency prior to 10 years.  You might be able to negotiate for a payment reduction or enter into a repayment plan.  Regardless, you’re pretty screwed.***

9. You have $25,000 in credit card debt on a card that charges 26.49% interest, compounding 360 times per year.  If you make no payments, how much will you owe in 8 years?

FV = 25,000(1 + 0.2649/360)360*8 = $207,949.76

10. You open your credit card account online.  You find that you have a $3,600 current balance, a $2,100 statement balance, and a minimum required payment of $100.  Assume that each payment is made “on time”.

a.       Explain what will happen if you pay $100.

You will not be charged any late fees, but you will be charged interest on the different between your payment and the statement balance (interest applied to $2,000)

b.      Explain what will happen if you pay $2,100

You will not be charged interest or fees.

c.       Explain what will happen if you pay $3,600

You will not be charged interest or fees. (But, I would argue that this is wasteful.  You could only spend $2,100 and invest the extra $1,500!)

d.      Explain what will happen if you pay $1,000

You will not be charged any late fees, but you will be charged interest on the different between your payment and the statement balance (interest applied to $1,100)

e.       Explain what will happen if you pay 2,500

You will not be charged interest or fees. (But, I would argue that this is wasteful.  You could only spend $2,100 and invest the extra $400!)

11. Based on what you’ve learned, do you think that personal finance experts or members of the general public will benefit more from using credit cards?  Explain.

Experts!  Those that fully understand the credit card game, are responsible with their spending, and are willing to work hard to unlock benefits can generate significant gains from cards via payment floats, cash back, minimum spend bonus, and other perks.

12. Explain why it’s advisable to choose a no annual fee credit card as your first card.

To establish a credit score, many folks need to get a credit card.  If they ever close the card account, it’s possible that this person will become credit invisible and lose their entire credit history.  To avoid this possibility, it’s smart to get a no annual fee card and keep it forever—it doesn’t cost anything, so it’s no big deal to keep it! 

13. What interest rate do debit card companies charge if I only pay the minimum payment on my debit card account balance?

Trick question.  This is not how debit cards work!  Debit cards are directly connected to your bank account.  When you spend money with a debit card, you aren’t really borrowing. Rather, your money is transferred from your account to pay for the transaction with a short delay of a couple of days.