Are Penalty-Free Credit Cards Really All That?

If you’ve noticed commercials on TV or the radio lately that advertise no-penalty credit cards, it’s no surprise – they’re a hot commodity now. Citigroup, Discover, and Wells Fargo are just a few companies that offer no-penalty cards. Issuers promise to eliminate one or all penalty fees, including late fees, increased interest and over-limit fees. Sounds great, right?

Well, not so fast. While no-penalty cards definitely seem attractive, the old saying “Nothing in life is ever free” comes to mind. Before you rush out to apply for a card that you think will never penalize you, read on to find out how these promises can be misleading.

If you could really benefit from it, you probably don’t qualify for it.

No-penalty credit cards aren’t actually targeted to people who miss payments. Most people who qualify for Citi’s no-fee Simplicity card, for example, have an average FICO score in the mid-700s, which is considered good credit. Credit card companies make a lot of money on fees (think somewhere in the ballpark of nearly $18 billion a year, according to a June 2011 report), and waiving fees for the people who pay them the most often would cost the companies a fortune in the long run.

Delinquencies are still reported to credit bureaus.

You may not get hit with a fine if you’re late, but if you’re more than 30 days late on your payment, you’ll be reported to the three credit card reporting agencies all the same. This is where the real penalty begins. The FICO credit scoring system, which is used by most lenders, bases 35% of your credit score on whether or not – and how often – you pay your bills on time. According to one estimate by FICO, one 30-day late report can lower your score by anywhere from 80-110 points. This means higher interest, a harder time qualifying for credit . . . you get the idea.

Some advertised “benefits” aren’t really benefits.

Before the Credit CARD Act of 2009, credit card issuers had the ability to hike interest rates to the highest legal limit if you were just a day late on your payment. Under new regulations, however, credit cards can’t increase rates unless you’re at least 60 days late. What’s more, they have to notify you in writing at least 45 days before the rate goes up. So legally, you have three months before your interest rates can go up. These rules apply to all credit card companies.

What does this mean for you? No-penalty credit cards that boast they won’t raise your interest rate if you’re late aren’t doing you a favor—they’re simply obeying the law.

Rewards are non-existent.

One of the great things about credit cards is the ability to earn perks and rewards like airline miles, discounts, gift cards, cash back, and more. With a no-penalty credit card, not having to pay a penalty if you’re late is the reward – the only reward.

So are no-penalty credit cards worth the hype? When you compare them to some of the other cards out there, probably not. While the lack of penalties is a definite perk, it’s pretty much the only perk, and if you qualify for a no-penalty credit card, chances are you already have good credit. That means you’re probably qualified for a card with a lower annual interest rate that offers rewards you’ll actually use.