A 912.99% interest rate?! Yes, it’s true… due to a minimum finance charge for purchases.
Also referred to as the “minimum interest charge fee” it’s surprising how many people don’t know what this term means. It’s extremely important to know, especially for those outside the United States. So what is it exactly?
Definition: Minimum Finance Charge – The minimum fee charged when a credit card account has a balance subject to interest charges. It only applies when the actual finance charges are less than the minimum finance charge. Usually this amount is $1 or $2.
If you’re still confused let me give you an example… Let’s say you are carrying a $10 balance on your credit card account and paying interest on it (obviously stupid to do, but this is just an example). And let’s say the the monthly (not yearly) APR equaled 1%. That would mean for the first month, you would be charged $0.10 of interest (1% of $10). However if your account has a minimum interest charge fee of $1.00, then that $0.10 would fall below that threshold. So what does the credit card company do? Instead of charging you the actual interest which equals only $0.10, they charge you $1.00 since that is the minimum.
How this charge can magnify your actual interest rate
In a nutshell, if you carry a small balance that is subject to a minimum finance charge, then the actual amount of interest you pay will be higher… since you’re paying the $1.00 to $2.00 per month fee versus the actual (lesser) interest charges. Let me give you a real life example that happened to me several years ago… In order to pay medical bills, I used my Bank of America credit card for a 0% balance transfer offer to the tune of $10,000. Now since that amount qualified for the 0% I wasn’t getting charged any interest on it. However I made a huge mistake… I accidentally used this card to make a small $2 purchase. And since all payments automatically went towards the lower rate balance first (the $10,000 at 0%), not a single penny of my payments went towards paying off that $2 charge (which was accruing at the normal purchase APR). So although the $10k wasn’t costing me a dime of interest, that $2 was! And as you can imagine, with an annual APR of 12.99%, the actual monthly interest on that $2 purchase was only around 3 cents. However, since Bank of America’s minimum finance charge was $1.50 that’s what I got charged each month instead. That means over the course of 12 months, that $2.00 purchase accrued a total of $18.00 ($1.50 x 12) of interest charges! When you do the math, that means my actual realized APR was 912.99 percent!
Will this happen to you?
Thanks to the CARD Act (credit card reform) that is now in effect, your payments are applied towards the higher rate balances rather than the lower rate balances. So my predicament would never happen today, because my payment would first go towards that $2.00 charge, before the 10k at 0%. However in most countries outside of the United States, minimum payments are still applied to lower rate balances first. That means something like this can still happen if you live elsewhere. But believe it or not many people – both in the U.S. and abroad – voluntarily choose to put themselves in a situation like this… still to this day! How so? Well some people falsely believe carrying a balance is better for their credit record, so instead of paying off their balance in full each month, they choose to keep $10 or $20 unpaid. That $10 or $20 then accrues interest and due to the low amount, it almost certainly gets hit with the minimum interest charge instead each month.
One last word of caution
Just a few years ago the average minimum finance charge was $0.50 cents but that has been rapidly creeping up over the past decade. These days, most major credit cards operating through the Visa, MasterCard, American Express and Discover payment networks typically have a minimum finance charge of $1.00, $1.50, or $2.00 (however it’s the bank, not the payment network, that chooses the amount). Store and gas station cards sometimes run even higher as I have seen a few that charge as much as $4.00 per month! So if you take away one thing from this post, it’s that it NEVER makes sense to carry a balance if the amount is so small, that it causes you to be hit with this fee. If you have a balance that tiny, just pay the thing off!