13 March, 2007

0% APR for life credit cards.

You know how banks offer credit cards with 0% APR for 6-12-18 months, so you get used to not paying off the whole balance during the grace period and get slammed with 15-18-24% rate once the promotional period expires.

It is interesting to note, however, that potentially banks could keep 0% rate forever, and still make profit, as long as you pay off your balance on time (and I guess they are making profit even if you always repay your debt within the grace period).

Suppose you get a credit card with $1000 limit, then buy some stuff for the whole $1000, then send a $1000 check to the bank a couple of weeks later and then restrain yourself from shopping sprees, admiring how you're living by your means. In effect, the bank gave you $1000, received it back from you and keeps it. So if you don't go buy another $1000 worth of stuff on the very day the bank got your $1000 back, the bank gets to use your money as it sees fit. For example, it can give someone a mortgage or a business loan and get a few pennies of interest on that $1000. And if they have 100,000 customers, each giving them a $1000 for a few days, these pennies add up to millions of dollars.

But that of course works only if you pay regularly and, more importantly, don't go waste all of the credit limit at once, but instead spend a $100 here and a $20 there, then the bank gets to use your money longer.

Therefore paying off the balance does not mean the bank gets no profit, I wonder if it gets even more profit then off those poor folks who just pay a minimum payment every month, thus being able to admire the wrath of 24% APR spreading its black wings across the Universe. See, if you don't pay off the whole balance, and may be get to pay an occasional overlimit fee, your credit limit probably isn't very high. And as the wise science of mathematics teaches us, even the humongous (24% APR) of multipliers can be brought to near-zero if multiplied by a near-zero number ($250 credit limit). On the other hand, if you are a fat cat with $50K credit limit and buy a G35 for the Junior to drive to school and pay off the whole ~$40K balance the very same month, the bank gets to use those $40K almost indefinitely.

So whether you're "financially responsible" or not, pay off credit cards or not, banks get profit anyway. Which is obvious, of course, but it was interesting to analyze the mechanism.

2 comments:

CreditCustomer said...

Absolutely right. I'd like to add that credit card companies will hit you with fees and interest when you miss payments. Of course, banks get profit anyway, but they will get much more if you are late with your payments.

Karen said...

No matter what type of credit card you have (even if it is 0% APR one) you still have to pay some fees. Banks have to profit from something.