Is There a Catch to No-Penalty Credit Cards?

No-penalty or no-fee credit cards, including the Citi Simplicity and Discover It cards, are popping up all over the place, luring customers in with the promise of no penalties or fees for making late payments or going over the credit limit. But like any offer that sounds too good to be true, there's usually a catch.

No-Penalty Cards: The Facts

Before signing up for a no-penalty credit card, take a look at why “no-penalty” claims can be a little misleading:

People who make late payments won’t qualify.

Interestingly enough, the people who benefit most from a penalty-free card probably won’t qualify for one. In order to qualify for this type of credit card, you need to have a good credit score already. The Discover It card, for example, requires “excellent credit”, which is usually somewhere in the 750 to 850 range. If you make late payments on occasion or go over your limit, then your credit score will probably be too low to qualify.

Interest rates tend to be higher.

The interest rates for Citi Simplicity and Discover It range from 11% to over 22%. If you plan on carrying a balance on your credit card, there are other cards that offer lower interest rates. Given the credit requirements for penalty-free cards are roughly the same as a lower interest-rate card, you’re better off getting a card with lower interest.

“Benefits” aren’t always benefits.

One of the biggest marketing claims of penalty-free cards is the promise that your interest rate won’t go up if you make a late payment. What they fail to tell you, however, is that this “benefit” is actually the law. According to the Credit CARD Act of 2009, you must be 60 days late before a credit card issuer can raise your rate. Even then, they have to notify you 45 days in advance, giving you the opportunity to pay your card off or close it before your rate goes up. This law applies to all credit cards, not just penalty-free or no-fee cards.

Late payments still affect your credit.

The credit card company may not charge you a fee if you make a late payment, but delinquencies over 30 days are still reported to the credit reporting agencies. And since late payments can stay on your credit report for up to seven years, reported delinquencies are a far lasting penalty than a late fee. Because payment history accounts for 35% of your overall credit score, just one late payment can drop your score anywhere from 50 to over 100 points.

It’s not a rewards card.

Most people choose credit cards based on the rewards it offers, like cash back or airline miles. With no-penalty credit cards, not having to worry about being charged penalty fees is the only reward.

No-Penalty Cards: The Verdict

So are no-penalty cards a good choice? That depends. If you have a good credit score and can qualify for a lower interest card that offers more rewards, a no-penalty card may not be your best bet.

On the other hand, a no-penalty card could be a good choice for you if:

• You like the peace of mind of not worrying about fees. If there’s a chance you might make a late payment or go over your credit limit, a no-penalty card could take the stress of worrying about a hefty fee away.
• You don’t carry a balance. Because no-penalty cards have higher interest rates, they’re best suited to those who don’t plan on carrying a balance on their card from month to month.

While there is a catch (or two) when it comes to penalty-free cards , they’re not all bad. Just make sure you know the pros and cons before you sign up for this type of card.