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Frequently asked questions about credit cards

How do lenders and credit-card companies make credit-granting decisions?
When a lender or credit card company reviews your credit application, it’s basically trying to gauge the likelihood that you can -- and will -- pay the money back. They do this by examining your "Three Cs": character, capacity and credit. Character: Credit grantors get a sense of your financial and personal character through such factors as the length of time you have lived in one place and the length of time you have stayed on your current and previous jobs. They get this information from your credit application. Capacity: This refers to the amount of debt you can realistically pay given your income and savings. To estimate your capacity, lenders look at your current living expenses, debts and the additional payments that the proposed new obligation would require. This information comes from your both your credit application and credit report. Credit: A key factor here is how you have handled your current and past credit relationships. Do you pay your bills on time, or are you habitually late? What are your current credit limits, and how close are you to those limits? The answers to such questions can usually be derived directly from your credit report.

What kind of credit card should I get?
Before you start shopping for a credit card, think about what kind of card holder you are. Do you pay off the entire balance at the end of every month? Or are you the type who likes to make only minimal payments? If you pay a card’s entire balance at the end of each month, you don’t really need a card with an extremely low interest rate because you probably won’t have to pay any finance charges anyway. Instead, search out credit card companies that charge no or very low annual fees. If you instead tend to carry an outstanding balance on your credit card from month to month, look for card issuers who charge unusually low interest rates. Just a one percentage point difference can make an enormous difference-- far more than a $25 or $50 annual cardholders fee. Better yet, develop the habit of paying your entire balance every month, and get free of costly credit card debt.

What is a debit card?
A debit card looks like a traditional credit card. Many sport the familiar VISA or MasterCard logosh. However, debit cards are quite different from credit cards. A debit card is usually linked directly to your checking or savings account. You can use a debit card to buy groceries or gas, but the money is automatically (and instantly) taken out of your account. Using a debit card will help you avoid accruing finance charges, but you miss out on the interest-free "float" period, usually 25 days, offered by most credit cards, although that is only a benefit for those who pay off the credit card balance in full each month.

What is the difference between a debit card and a credit card?
A credit card is issued by a bank or other financial institution that guarantees to pay for anything you buy with the card. For this privilege, you typically pay an annual fee for the card and interest on unpaid balances. Debit cards, on the other hand, are usually linked directly to your checking or savings account. You can use a debit card to buy groceries or gas, but the money is automatically (and instantly) taken out of your account. Using a debit card will help you avoid accruing finance charges, but some merchants charge 50 cents or as much as $2 to process each debit card purchase.

What is a single-purpose credit card?
Single-purpose credit cards are issued by a specific company and honored only by that company and its affiliates. Department stores are the biggest issuers of single-purpose cards, but some hotels, airlines and even telephone companies issue them too. They are sometimes easier to obtain that broad-use credit cards, in part because retailers are anxious for your return business.

What is a secured credit card?
Secured credit cards work differently than traditional credit cards. But if you have a bad credit record -- or are just starting to build a credit profile -- a secured credit card may be the only type you can get. To get a secured credit card, you must usually make a cash deposit into a bank account. In return, the bank gives you a Visa or MasterCard with a limit that’s equal to 50% or (sometimes) 100% of the amount you have on deposit. Depending on the bank’s policies, it will either debit your deposit automatically when you charge something on the card or it will send you a statement and allow you to pay the balance with a personal check. If you don’t pay the money back on time, the bank will take it out of your deposit whether you like it or not. Secured cards aren’t as flexible as traditional credit cards, because you have to tie up cash of your own and cannot charge more than you have in the bank. However, it’s a good way to establish credit if you’re just starting out. It’s also a first step toward re-establishing a good credit rating if your record is spotty. After you have shown the bank that you can be relied upon to make your payments promptly, it may offer you a conventional card, or you can apply for a conventional card issued by another company.

What are travel and entertainment cards?
Travel and entertainment cards are credit cards with a twist: They don’t charge interest to the cardholder, but their entire balance must be paid every month. Diners Club, American Express and Carte Blanche are examples. Some of these cards come with higher annual fees, and many of them carry companion interest-bearing cards, such as the American Express Optima card.

Where do I find low-interest credit cards?
The credit-card business gets more competitive every month, so it’s important to shop for a card with the best rate and terms. Bankrate lists the best credit-card deals nationwide, including several with no annual fee and interest rates of less than 12%. But it’s not enough to simply look for the lowest rate. If you pay your balance in full at the end of every month, for instance, the rate is almost irrelevant. Search instead for a card that charges no annual fee. Also, be sensitive to low enticer rates that then escalate after you sign-up.

What is APR?
The Annual Percentage Rate (APR) is the relative cost of credit as determined in accordance with Regulation Z of the Board of Governors of the Federal Reserve System for implementing the federal Truth-in-Lending Act. The APR is the actual yearly interest rate paid by the borrower, figuring in the points charged to initiate the loan and other costs. The APR discloses the real cost of borrowing by adding on the points and by factoring in the assumption that the points will be paid off incrementally over the term of the loan. The APR is usually about 0.5% or greater than the note rate.

What is the effective interest rate?
This is also referred to as the effective annual rate (EAR). The effective rate is the relevant rate since it represents what you are actually paying or receiving. For example an 8% stated rate paid annually on a $1,000 investment is $80 per year. However, if the interest is paid quarterly, the annual effective interest is (1.02)^4 - 1 or 8.24% which results in $82.40 per year. The formula is read, "1.02 raised to the 4th power minus 1." The 1.02 is 1 plus the annual rate (8%) divided by the number of compounding periods in the year (4). Generally, stated rates are advertised in large print and effective rates are disclosed in the fine print. Read the fine print because the effective rate is what you actually pay or receive. See also real interest rate and nominal interest rate.

What is the nominal, or stated, interest rate?
The nominal interest rate is the stated interest rate. It should be distinguished between the real rate and the effective rate. The nominal rate is the real interest rate plus the inflation rate. To determine an effective rate, you must adjust the nominal rate to reflect compounding periods and any interest add-on. Read the fine print to find out what you are actually paying or receiving. It most likely is not the nominal (stated) rate. See also real interest rate and effective interest rate.

What is the real interest rate?
The real rate of interest is the rate adjusted for inflation. For example, if the stated interest rate is 6% and inflation is 3%, the real rate of interest is approximately the stated rate less the inflation rate or, in this example, three percent (6% - 3% inflation = 3% real rate). See also nominal interest rate and effective interest rate.

What is the grace period on a credit card?
A grace period is the length of time a credit card issuer is willing to lend you its money for free. Many cards have 25-day grace periods. If you pay your balance in full before the 25 days are up, you are not slapped with any finance charges. If you pay only part of the balance owed, you’ll pay finance charges on the rest. Many credit cards have a grace period, which benefits the cardholder. However, such cards are getting harder to find as the credit card industry continues to look for more ways to make money.

What is a minimum finance charge on my credit card?
The minimum finance charge on a credit card is the minimum amount of money that a credit card company will impose on your monthly balance. Many cards charge a minimum finance charge of 50 cents. By itself, 50 cents isn’t a lot of money. But if your outstanding balance is just $15, that 50-cent charge works out to an annual interest rate of 40 percent!

What is the adjusted balance method of calculating finance charges?
There are three ways credit card companies calculate finance charges. Of the three, the adjusted balance method will result in the lowest. When you make a payment on a credit card that uses the adjusted balance method, the company will simply subtract the amount of your payment from the balance at the beginning of the monthly billing cycle and charge you interest on the remainder. This results in lower finance charges than the average daily balance method, which bases finance charges on the average of the amount you owe each day, or the previous balance method, in which your payment won’t be used to reduce the previous month’s bill. All other things being equal, it’s best to choose a credit card that uses the adjusted balance method to calculate your finance charges.

Can I cancel my credit card to avoid paying the annual fee?
If you have a credit card that you want to cancel in order to avoid its annual fee, all you need to do is call the credit-card company and say that you want to close the account. Of course, you’ll have to pay any outstanding balance that you owe. In many cases, if you tell the company that you’re closing the account to avoid the fee, they will waive the fee in order to keep you as a customer. Make sure you ask the company to report that the account was closed voluntarily, at your request. If the card company simply reports to credit bureaus that the account was closed, future creditors may think the company itself closed it because you weren’t paying your bills. If that happens, it will be more difficult to get a new credit card or a loan in the future.

What is the over-limit fee that appeared on my credit-card statement?
When the amount that you have charged on your credit card exceeds your established credit limit, many credit-card companies will hit you with a nasty "over-limit" penalty or fee. The charge could top $25 or $50 -- as if charging 12% or even 20% on your outstanding balance isn’t already enough. Some banks and credit card companies will waive their over-limit fee if you call and ask, especially if you haven’t exceeded the limit and asked for a waiver before. Even if the company agrees to waive the penalty, consider it a warning that your spending might be getting out of control. Put the card aside, eliminate frivolous purchases, and start paying cash.

Should I get credit disability insurance?
Many direct mail and credit card companies offer credit disability insurance, which will pay off your credit card bills (or at least make the minimum monthly payment) for you if you become unable to work. But the cost of this insurance is extremely high -- especially for the relatively small amount of protection it provides -- so most people are better off without it. A broader policy that will provide you with a steady income if you become disabled is a more cost-effective choice. One exception to this credit disability insurance rule is if you are in poor health and can purchase the policy without a medical evaluation. In that case, these policies may be the only ones you have access to. This is another reason that these policies are expensive. If you’re in good health, you are paying for the people with poor health who can enroll without a medical examination and who undoubtedly make more claims.

What are my rights if I want to dispute an item on my monthly credit card statement?
Under the law, credit cards provide some strong consumer protections regarding purchases. You have 60 days to notify the lender in writing about billing errors. This includes wrong amounts of credit extended, wrong goods or services, incorrect payments or credits, computational errors or any other disputed charges. Card companies have 30 days to respond and 90 days to resolve the problem. They can’t stop you from using your card while investigating the problem and can’t release a bad credit report on you. And if they don’t respond, they can’t collect the disputed amount or finance charges.

Is it a good idea to pay off credit-card bills with savings?
If you have some extra money in your savings account, give serious consideration to taking the cash and paying off your high-interest credit cards or auto loan. You’ll benefit because the interest you earn on your savings is probably far less than the interest you’re paying on the credit card’s balance or loan. If you have loans at, say, 12%, paying them off is like finding an investment with a guaranteed return of 12% tax-free. You would actually need to find an investment that yielded even more -- around 18% -- to net 12% after paying taxes to justify not paying your 12% loans.

What’s my liability if my credit card is lost or stolen?
Credit cards are often stolen or lost, but your liability is extremely limited. If you report a missing card immediately, federal law requires that the credit card company shoulder the cost of any illegal charges. Even if you don’t report the card stolen, the most you can generally be expected to pay is $50.

What is identity theft?
Identity theft happens when a person wrongly assumes another person’s identity for financial or other purposes. The identity thief obtains vital data about his or her victim -- social security number, credit card account numbers, date and place of birth, etc. Once the thief acquires enough information, he or she is able to obtain credit cards, bank accounts, a driver’s license and other financial and legal documents in the victim’s name. Identity thieves buy houses and cars fraudulently. They get married using their victims’ names. They even are arrested under their victims’ names. The Federal Trade Commission maintains a Web site with information about identitfy theft.

How can someone steal my identity?
It can be ridiculously easy. All they have to do is get some personal information about you. Some thieves get started by being friendly and asking the victims and the victims’ family innocent-sounding questions, such as "Where were you born?" Others may steal your wallet, go through your trash for old discarded financial records, legally read official court records of your divorce proceeding, or steal your mail. Still others may craft official-looking e-mails and trick you to answer them. Dishonest employees have access to credit bureau records. A friend, a relative or a roommate could steal your identity by getting information about you in your own home.

How can I find out if I am a victim of identity theft?
Many people never find out until a collection agency or a store contacts them, looking for payment on an unfamiliar bill that the thief has run up. Before that happens, check your credit history with the three big credit agencies, Equifax, Experian and TransUnion. If you see any unfamiliar credit card accounts, or a history of application for credit cards that you never made, there is a good chance that someone is using your name for their own gain.

Am I responsible for the bills identity thieves run up in my name?
Federal credit fraud law protects you here. Credit card and other companies that wrongly extend credit in your name must obtain the money from the identity thief, or eat the losses, minus $50 they could ask from you. (Many creditors never ask for that $50.) But your identity theft could cost you in other ways. You will spend time and money fixing your credit record and convincing creditors that you have been wronged.

What can I do to stop an identity thief and restore my credit rating?
1) Report the identity theft to local law enforcement authorities, including the police, postal inspectors and Secret Service. A new federal law makes identity theft a crime for offenses that federal lawyers can prosecute. Unfortunately, however, not all states have such laws on the books, and if yours is one of them, you may find an unsympathetic local police department not willing to pursue the matter. States with identity theft laws include Arizona, California, Colorado, Georgia, Kansas, Mississippi, New Jersey, West Virginia and Wisconsin. 2) Contact all banks and other companies where your name has been used fraudulently, sending a copy of a police report or other documentation to show that you are a fraud victim. 3) Contact the fraud departments of the three major credit bureaus to get copies of your credit report and to have fraud flags and statements added to your reports. The reports will usually be issued free of charge to someone who has been the victim of credit fraud. The three are: Equifax (888) 909-7304; Experian (888) 397-3742 and TransUnion (800) 888-4213. Request that each bureau have fraud flags and statements added to your reports saying that all potential creditors should contact you to verify applications for new credit. Ask the bureaus to clear the fraudulent accounts off your record. 4) If all else fails, contact a lawyer. Strongly worded letters and threats of a lawsuit from an attorney may prompt credit agencies or stores to pay more attention to your case.

What steps can I take to prevent my identity from being stolen?
Don’t carry unneeded credit cards, your Social Security card, your birth certificate or other personal documents in your purse or wallet. Keep track of all your ATM, credit and debit cards as well as receipts from these cards. Either store them in a safe place or shred them. Shred unneeded personal documents and mail with identifying information before throwing them out. Cancel all unused credit card accounts. Keep a list of your credit-card account numbers and the companies’ telephone numbers in a safe place so you can cancel them quickly and easily in case they are stolen or lost. A handy way of doing this is to use a copy machine. Just be careful where you leave the hard copy. Protect your Social Security and other personal data as much as you can. Do not give out personal information to any person or company unless you are familiar with them and you have initiated the communication with them. Do not provide any person or corporation with personal information unless you have contacted them first or are certain you can trust them.

What’s the purpose of that black stripe that runs across the back of my credit cards?
Virtually all credits cards now have a black magnetic stripe on their back that has a variety of information coded into it. Although your credit cards probably only have one stripe, there are probably two "information tracks" on it. The first track includes information such as your name, the card’s expiration date, your credit limit and your personal identification number. The second track is the one with your individual account number, the date you opened the account, and other discretionary data.