When Small Fees Equate to High Interest Rates

There are many ways to hide banking fees so that customers don’t notice them.  One way is to quietly help yourself to a couple percent of people’s mutual fund savings every year.  Another is to tack a foreign exchange fee onto the exchange rate when customers exchange currencies.  I learned about a new one recently with credit card payment plans.

Many of the big banks offer plans that allow you to take a credit card purchase and pay it off over 6 months to 2 years at a low-sounding interest rate.  The trick is that they add fees that also seem small, but they add up.

One example is TD’s credit card payment plan that allows you to pay for large purchases over 6 months at zero percent interest for a one-time fee of 4%.  This sounds way better than paying standard credit card interest rates.  However, looks can be deceiving.

Suppose you make a $600 purchase.  With the 4% fee, this grows to $624.  At 0% interest, you could use the payment plan to pay off this purchase with 6 monthly payments of $104.  Even though the fee is only 4%, the implied annual interest rate with this plan is 13.6%, which compounds to 14.5%.

This may not be a big deal for a single purchase, but if you’re routinely using this plan for every large purchase, you’ve effectively got a 14% credit card, even though it seems like you’re only paying 4%.  In a perfect world, banks would have to disclose these facts to their customers in a way they can understand, but I’m not holding my breath.