Are Store Credit Cards Worth the Discount?

Dec. 28, 2009— -- Many of us hit the stores pretty hard during the holiday season. And you might have noticed that whenever you got to the cash register, they asked you if you wanted to sign up for a store-branded credit card. Usually you can get some kind of discount if you do sign up, but is it worth it?

"GMA" financial contributor Mellody Hobson, the president of Ariel Investments, says no.

"I want to be absolutely clear," Hobson said. "I would not get one."

Store-branded cards are popular with stores because, like any other discount, they encourage people to buy things they usually would not buy.

Hobson's advice is to avoid signing up for new credit cards, because the more cards you have, the more likely you are to spend money that you don't have. The average credit card debt per American household is above $8,300, according to creditcards.com.

"Why are [retailers] so anxious to sign us up for this?" Hobson asked. "We spend more money when we use a credit card."

'Enticing' Discounts With Store-Branded Cards

Most stores offer a discount off your purchase or a period of time with no interest if you get a store card, also known as private-label cards in the industry. Best Buy is offering no interest charges for 18 months on all purchases greater than $249 if you sign up for a card.

The offers are "very enticing," Hobson said. "The idea is that you get these teasers. All of this sounds super until you actually do the math." If you aren't able to pay for the item in full and only make minimum payments, the interest charges will often wipe out any savings you got from opening the card in the first place.

Store cards don't have put you through same approval process as regular credit cards. Retailers do a quick check of your credit score, and you can be instantly approved to use the new card at the point of purchase.

Because of the limited verification, retailers can offer private label cards to consumers who are less likely to qualify for other types of credit and then charge them interest rates over 20 percent.

Because of the high interest rates on store cards, "they make a lot of money," Hobson said. "These cards are really profitable."

According to bankrate.com, the average variable interest rate for a regular credit card, or prime card, is around 12 percent.

Many of these cards also have an additional delinquency rate, Hobson warns, so if you miss a payment or two your rate can jump above 27 percent. Delinquencies for private label cards are usually 1-2 percent higher than prime cards.

Store Cards: Discounts vs. Dangers

This high delinquency rate is part of the motivation behind new restrictions proposed by the Federal Reserve that would make it more difficult for stores to approve credit instantly by requiring them to gather proof of income, The Wall Street Journal reported this month.

Impact on Your Credit Score and Credit History

In addition to the higher interest rates that these private label cards charge, Hobson says that just by opening up a new card you are lowering your credit rating.

"It absolutely lowers your credit score when you open up one of these new accounts," Hobson said. "That's just the way the math works for the credit rating agency."

A lower credit score can affect your ability to get a car loan, rent an apartment, or even get the job you want.

Ten percent of your credit score is affected by new accounts, and the more accounts that you open up, the more of a hit your credit score will take. Opening these store accounts will also reduce the average age of the cards in your credit history, which in turn will reduce your credit score because "[credit agencies] like to see longer, older credit history."

The average age of your credit history accounts for another 15 percent of your total credit score, and opening new cards "suggests that you're more of a credit risk," Hobson said.

Because store cards usually have low limits, your credit utilization -- the amount of your credit line you're using -- will be higher. If you have a $500 limit and a $300 balance, then your utilization is 60 percent, but if you had a $1,000 limit and a $300 balance, then your utilization would only be 30 percent. Credit utilization makes up 30 percent of your score.

The Credit Card Accountability, Responsibility and Disclosure Act of 2009 (CARD) goes into effect in February, but Hobson says "it won't really change any of this math that I'm talking about."

"It won't really change anything about the interest rates," she said, but added that "it will change the transparency. Now your credit card statement will show how many months will take to pay off that balance."

The provisions of the CARD act also require retailers to get more details about applicants in their application, and credit card issuers are required to clearly disclose their terms.

Should You Cancel the Cards You Have?

If you're carrying a balance on a store card, it's better to cancel the card before your retailer increases the interest rate.

"In canceling the card, you will take a hit to your credit score," Hobson said. "But that hit usually repairs itself in a year or so" if you pay your bills on time and manage your debt.

It's a "better option than carrying the balance and interest," she said.

But opening an account just to get a discount and then canceling the account after you pay off the purchase is a bad idea, Hobson says.

Web Extra: What to Look For If You Get a Store Card

If you do decide you want to sign up for a store card, Hobson has two pieces of advice:

Pick a Card With a Low Interest Rate

Make sure you read the fine print, she says, and try to pick a card that has a low interest rate, especially if you know you usually carry a balance. Some cards have an introductory interest rate, which then dramatically increases after a certain amount of time.

Also make sure you understand the financing terms for the card. Some retailers have no interest charges for twelve months, but if you miss your payment a year later, they may calculate interest charges from the day of your purchase. This will essentially wipe out any benefit you received from the card. You should only get one of these cards if you are responsible with your credit and regularly shop at that store.

Seek Out Store Relationships

Secondly, sometimes stores have special relationships with other stores, so you can use one store card at another or vice versa. This will prevent you from signing up for additional cards that you do not need, and in some cases you may get rewards at one store for purchases made at the other store, depending on the rewards program. Some examples include Kmart and Sears; Gap, Old Navy and Banana Republic; and Bergdorf Goodman and Neiman Marcus.