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 Barclaycard, 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 (like American Express did with Costco), 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.