People often debate the merits of one credit care versus another, as though certain cards have what even seems like a virtue at first glance! But is that really true? Credit cards are something of a financial iceberg—the part you can see looks almost benign—and sometimes even pleasant–but the part you don’t see is where most of the costs are hiding. And those hidden costs are buried in places we don’t often look.

Let’s take a look at the hidden cost of credit cards:

Underestimated financial costs

We all know about the interest we pay on credit cards—that one’s pretty easy to figure out. But if you buy on credit and carry balances, the interest expense you pay on your credit card increases the cost of everything you buy. Let’s say that you have a credit card that you normally carry a $5,000 balance on and that the card carries a 10% rate of interest (a pretty low number for a credit card); virtually everything you purchase will then cost 10% more, and that’s just in the first year.

Let’s say that somewhere buried in your balance is a widescreen TV set that you paid $1,000 for. Within the first year of ownership of your TV, you’ll have paid $1,100 for the set—the $1,000 purchase price, plus 10% interest, or an extra $100. And that’s only in the first year of buying the TV! Interest costs will continue to increase the purchase price until the balance is paid in full. It’s not inconceivable that the true cost of your TV will ultimately rise to $1,200, $1,300, $1,400 or more. The discounts that you pay for purchases when you buy on sale may even be wiped out by future interest costs. [And you thought you were so smart because you researched the TV and got a deal!]

The income tax gross-up

Paying interest on credit card balances is bad enough, but it’s only the beginning. Though we tend to look at expenses in terms of visible costs, it would be better to consider all expenses in light of the question: how much income will I need to earn in order to pay this credit card expense?

Going back to our example above of having a credit card with an average balance of $5,000 and an interest rate of 10%, we can see that our annual interest cost on the card will be in the neighborhood of $500, right? Nope!

How much income do you need to earn in order to cover $500 in interest? If you’re in the 28% marginal tax rate on federal income taxes, 8% on FICA (roughly) and another 8% on state income taxes, or 44% in total, you’ll need to earn about $893 to cover the interest costs. That’s pretty close to double the cost of the stated interest expense!

If you take the income tax gross-up on the income you need to pay the interest on your credit card balance each year, the effective rate is actually 17.86% ($893 divided by $5,000) — which is far higher than the 10% you think you’re paying. [And remember, 10% is a low credit card interest rate.]

Ease of purchase

Ever wonder why nearly every merchant and vendor in the known universe accepts credit cards? Ease of customer purchase is pretty close to the top. Merchants know that credit cards have a way of breaking down buyer resistance—even if the customer has no cash in his wallet and insufficient funds in his bank account, he can still make a purchase, if he uses a credit card!

The “little voice inside” that’s warning you that you can’t afford to buy an item is effectively silenced by a wallet full of credit cards. That voice is one of your best defenses against overspending or going into debt, but it’s been muzzled by a piece of plastic!

Potential to play the “extension of the paycheck” game

This is very closely related to ease of purchase, but it goes one step beyond. It raises credit cards to the level of a strategic financial tool, akin to “bargaining with the Devil” when funds are in short supply. Credit cards are something of a personal “over and short” account, that can easily be used when expenses are over or income is short. In not a lot of time, this can easily turn into a game that’s played to cover what you can’t afford.

It’s easy enough to see where that can lead. I recently heard that borrowing is like reaching into the future to pull income into the present. Some people can resist that temptation, others can’t, and if you can’t it usually doesn’t have a happy ending. You’ve undoubtedly heard the term “two income households”? In severe cases, there can be “three income households”, two paychecks and a monthly credit card draw.

The draw of credit card “rewards”

Finally we come to credit card rewards. How is that a hidden cost? Any add-on that incentivizes spending money is ultimately a cost. Credit card companies don’t have rewards programs because they want to be nice to you; they do it because they know you’ll spend more if you’ll get a 2%, 3% or 5% reward for doing it. So instead of buying $5,000 a year for merchandise you buy on credit, you’ll buy $10,000, or $15,000, or maybe even $20,000. And why not—you’re being “paid” and extra two or three percent to do it, so you’re really coming out ahead, right?

Nope. Not if you’re buying more products and services than you would if you didn’t have the rewards benefit. The credit card companies know this. Oh, and the higher balances you’ll rack up for spending more money will also increase your interest expense—and the tax gross-up on the income you’ll need to pay it.

Opportunity cost

Remember how we talked about “reaching into the future to pull income into the present?” When you do that you are taking your future income and committing it to your current purchases; your stuff. But this means you can’t use this money for other things that may have more benefit long-term. This is the opportunity cost. The money you committed doesn’t get to be used for investing, retirement, savings, the house, car repairs, or anything else you may need money for in the future. Buy using your credit card now, you forfeit where you can use the money later.

Never assume that interest rates alone represent the total you’ll pay for the benefit of having credit cards. There are costs you don’t see, and others in the form of increasing your spending and all the expenses that go with that.