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Warnings From An Insider: 7 Store Credit Card Traps To Avoid

Editorial Note: The content of this article is based on the author’s opinions and recommendations alone. It may not have been reviewed, approved or otherwise endorsed by the credit card issuer. This site may be compensated through a credit card issuer partnership.

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7 Store Credit Card Traps To Avoid

This holiday season, you will likely be offered a store credit card. You need to be careful before signing on the dotted line. Although the in-store discounts might look appealing, there are some real dangers and traps you need to avoid. (And I know, because I used to run a rather large credit card company).

Why are these products so dangerous? First, the retailer just wants you to spend as much as possible. So, all of the incentives will be to get you to spend more money than you had originally planned.

Second, the credit card companies pay a lot of money to the retailers in order to get the credit card deal. Typically, credit card companies have to pay a “bounty” for every credit card booked to the retailer. In addition, most credit card companies have to share a percentage of interchange revenue with the retailer. (Interchange is the fee paid by merchants to credit card companies when a card is used for a purchase). Because credit card companies have to give all of this money to the retailer, they need to make it up somehow. And the usual way to make back that money is by charging much higher interest rates.

You can get a good deal. I once moved into a new house. I was very tactical: I went shopping on a day with deep in-store discounts (Columbus day, ironically), and I applied for a credit card that had a 10% discount for purchases made on the day. Because I knew I would be spending more than $2,000, the savings (more than $200 for the credit card purchase alone) was a great deal. And, most importantly, I paid the balance in full at the end of the month. I had planned my purchase in advance and used the store card offer to save more money. That is the only way to get a good deal.

Here are the 7 traps to beware:

1. The interest rates are high, regardless of your credit score.

The vast majority of store credit cards do not offer lower interest rates for people with excellent credit scores. In other words, there is no risk-based pricing. In addition, the average interest rate on store cards is much higher than traditional credit cards, and often starts with a “2”. Even people with an 800 FICO would receive a 20% (or higher) interest rate on most store cards.

2. 0% financing is not really 0%.

Most store cards will offer some form of 0% financing. However, most store cards do not waive the interest. Instead, the interest is deferred. If you pay off the balance in full during the promotional period, you don’t pay any interest. However, if you don’t pay the balance in full you will end up getting charged interest retroactively at the high store card interest rate. Using deferred interest is a common practice. Even Apple, in partnership with Barclays, uses this offer.

3. Your Credit Score Will Be Hit With A Hard Inquiry.

When you apply for a store card, a hard inquiry will hit your credit report and your score. Although inquiries do not have a major impact (it could be as few as five points), the impact could be consequential if you plan on applying for a mortgage or auto loan in the near future. With a mortgage, five points could be enough to put you in a different pricing bracket, costing you thousands of dollars over the life of the loan.

4. Rewards for “out of store spend” are usually much better on other cards.

Store cards often have great rewards for in-store spend. For example, the Amazon Visa offers 3% cash back for purchases at Amazon.com. The Target Red Card offers 5% off in-store purchases at Target. However, the deals are much worse for spending out of store. For spending outside of the store, many credit cards offer no rewards or only 1%.

5. You will spend more money than you planned. Yes, you will.

The oldest “trick in the book” is an offer that gives you 10% off in-store spending on the day that you apply for the card. The purpose of the offer is to encourage you to spend more money than you planned. And years of data shows that people will in fact spend more money.

6. Because interest rates are high (and retailers demand it), store cards are willing to accept people with very low credit scores who have a lot of debt.

Retailers sign agreements with banks to issue store cards. These agreements come up for renewal every five or seven years. Retailers force banks to bid on the business, and it is “all or nothing.” If a bank loses a deal, it can be a huge hit. So, the power really sits with the retailer, who owns the customers. Retailers will demand higher bounties (payments when cards are booked), better rewards for consumers and better interchange deals. Retailers want to pay very little interchange for in-store purchases, and they want to collect as much interchange as possible for out of store spend. However, one of the biggest requests is “approval rate.” Retailers want banks to approve as many people as possible, for obvious reasons. As a result, banks will charge very high interest rates and will often approve people through store cards whom they would otherwise reject. There is a real danger that people with bad credit who are already in too much debt will get a line. Some store card programs approve people with FICO scores in the low 500s.

7. You will be pressured by a sales person.

Retailers are most focused on increasing sales. And giving someone a store card with a same day discount will increase sales. So, they will put a lot of pressure on employees to push credit card sales at checkout. The financial incentives for retailers can be sizeable. As a result, you should expect to get this sales pitch constantly and regularly. Stay strong!

Store cards are not all bad. Here are the three reasons why a store card could be a good deal:

  • You are making a big purchase and want to take advantage of the discount offered. You can afford to pay the statement balance in full and on time. And you are not applying for a mortgage or auto loan in the next six to twelve months.
  • You do a lot of shopping with one particular merchant. For example, you live at Target for most of your needs. Getting the big in-store discount would be more rewarding than a traditional 2% cash back credit card. But, this only makes sense (like all cash back cards) if you can afford to pay the statement balance in full and on time every month.
  • You are looking to rebuild credit, and have a lot of discipline. Because store cards approve people with lower credit scores, this can actually be a good tool. A store card with no annual fee is actually a much better deal than most other credit cards targeting people with scores below 650. Just make sure you never spend more than 10% of the available credit limit and you pay your balance in full and on time every month. By doing that, you can increase your score over time without paying an annual fee or interest. But, if you don’t have the discipline, don’t do it.

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Fine Print Alert: Discover’s Personal Loan Growth and FHFA Changes

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In our weekly Fine Print Alert we call out news from the financial community and shine a spotlight on any sneaky changes in the fine print. We also share our favorite reads from the week.

FINE PRINT ALERT

Discover gets aggressive in personal loans…

Discover has been quietly building a personal loan portfolio that is now $5.1 billion in size. Lending Club, which has received a significant amount of press, has originated over $7.6 billion since it was launched in 2007. In the small market of personal lending, Discover is a meaningful player.

The team at Discover launched the product in a very intelligent way. At first, they started by cross-selling loans to their existing credit card customers. By doing this, Discover kept acquisition costs low while building risk models and infrastructure. Now, Discover is expanding into the open market, accepting applications online and via direct mail from people who may not have a Discover credit card.

FHFA changes mortgage fees, but nothing really changes for consumers…

In the Friday announcement, the FHFA eliminated the 25 basis point upfront adverse market charge. This fee was implemented in 2008, and impacted all government-backed mortgages.

However, for most borrowers there will be no change at all, because the following mortgage fees changes were also made:

  • For borrowers with both an LTV of less than 80% and a credit score above 700, the standard upfront fee will increase by 25 basis points. In other words, the adverse market fee is removed, but the upfront is increased by the same amount.
  • The upfront fee will increase by 37.5 basis points for cash out refinances, investment properties and loans with simultaneous second financing (often called “piggy-back” loans). If a loan falls into more than one category (for example, cash out on an investment property), the increase can be more than 25 basis points
  • For jumbo conforming loans, the fee increases by 25 basis points. Jumbo conforming loans are greater than $417,000 and are offered in certain high-cost locations.

For most borrowers, there will be no change to the price that you are paying for a mortgage.

The impact will only be felt by borrowers who have investor properties, are looking to take cash out, or are using a second mortgage as a down payment.

Read the full article on the FHFA announcement here.

FAVORITE READS FROM AROUND THE WEB

  • Why get scholarships is bad advice If you have financial need, colleges typically deduct the amount of so-called “outside” scholarships from the free aid such as grants and their own scholarships that they otherwise would give you. Schools don’t have to reduce the loan portion of your package unless your outside scholarships exceed the grants and other free aid they were planning to bestow. Liz Weston explains how to make school more affordable on her site Ask Liz Weston.
  • How to prioritize retirement savings? Try these 3 steps Your first priority when it comes to saving for retirement should be to make sure you’re putting away enough money. But once you’ve earmarked a percentage of pay for retirement savings, where do you put it? Research shows that if you start saving 15 percent of your pay when you’re 35, you should have enough money by age 65 to live comfortably in retirement. Sharon Epperson covers the best way to create a tax-triangle in her story on CNBC.com.
  • Actually, young people SHOULD invest in their 401(k) plans The earlier you begin saving for retirement, the more you can take advantage of compounding. The money that you start saving in your twenties will start accruing interest, and then that interest will accrue interest of its own, leading to an exponential growth in the size of your account.To see why it’s a good idea to start saving in your 20s, consider the following thought experiment. Read Andy Kiersz’s full argument on Business Insider.

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Fine Print Alert: Discover Rolls Out New Credit Card Feature

Editorial Note: The content of this article is based on the author’s opinions and recommendations alone. It may not have been reviewed, approved or otherwise endorsed by the credit card issuer. This site may be compensated through a credit card issuer partnership.

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 FINE PRINT ALERT

Just Freeze It…

Misplace your Discover credit card? Don’t fret, you can “freeze it.” Discover recently rolled out a Freeze it® feature to customers, which enables them to put a freeze on a card and prevent any new purchases or cash advances from being completed. An alert will also come through to the customer if a transaction is attempted and declined while the card is frozen. Automated bills will continue to process as well as online purchases. Unlike a credit report freeze, this can be done in seconds and a simple click of a button can unfreeze a card.

Don’t forget to set up your text alerts to know if someone else is using your card for transactions!

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MAGNIFYMONEY IN THE NEWS

FAVORITE READS FROM AROUND THE WEB

  • Are You Smarter Than a Fifth Grader About Money? So I met with the fifth graders at Potter Gray Elementary in Bowling Green, Ky., to find out if they understand the basics of personal finance and, it turns out, they do. In fact, based on my experience, plenty of them seem to have a better grasp of what it takes to manage money responsibly than many adults. Cameron Huddleston from Kiplinger shares her experience talking to fifth graders about personal finance. 
  • Where Your Tax Dollars Went Tax Day is all about income taxes, which make up nearly half of all federal revenue. Here’s a breakdown of what each of your income tax dollars paid for in fiscal year 2014. Click to see the infographic on CNN Money.
  • Pay Them Off, Thirteen Student Loan Tips Tackling student loan debt requires a money mindset makeover of its very own. The weight of the financial burden is often multiplied by feelings of failure and discouragement. When job prospects are low and salaries are not even in the range to justify— let alone cover— what you owe for your education, it can be hard to imagine yourself financially well. Brandy Camille Huff shares her 13 tips on The Budgetnista Blog.