Credit cards are a bit like power tools – they aid in keeping your financial house in order, however, if you are not careful, they can do a great deal of damage.
The benefits of a credit card:
- Credit cards make budgeting very simple. If you use your credit card to pay for everything, you will instantly have a record of your spending, which can help you do a better job with your personal budget.
- Credit cards allow you to use the credit card provider’s money for free. If you pay your bill in full when it is due, you will have no interest costs on the things you purchase for anywhere from 15 to 50 days after you purchase your item.
- Many credit cards give away free trips, cash refunds, along with other rewards that are based on what you spend.
However, the disadvantages are steep:
- Credit cards can bankrupt you, or at the very least, leave you with massive debt that follows you for years.
- Card companies make money by lending money and charging interest if you don’t pay your bill before the due date.
It’s likely you do not think of card companies as banks, but the reality is that’s exactly what they are. Banks that lend you money and charge interest if you do not pay in time.
Still, the longer you take to pay all the money back, the happier the credit-card companies are, since interest keeps building if you keep using the card to buy things each month. Pay any bill even an hour late, however, and they may hit you with a late fee of $30 or quite possibly more and, in addition, your interest rate goes up.
Credit card companies place a cap or credit limit on each card, which determines how much you can owe at any given time. Previously, companies would allow you to spend beyond the limit. Then they would charge you with a separate “over the limit” fee that was at least $30. However, these days they can lower your limit, even when you have been a responsible customer, so make sure that you keep an eye on this.
If you get into huge debt as a result of going on a fantastic vacation or because you were over shopping, then you need to commit to pay your debt off before you start racking up a bunch of new charges. You do not want to find yourself with a 4 or 5-figure credit card debt hanging over you for decades to come.
How to choose a credit card
Once you commit to safely using plastic, picking the right card can still be highly complex.
Begin with one question and make sure you are being honest: do you believe that you will use the credit card to borrow money over the next several months, or are you going to pay it off monthly?
If you are going to borrow, then you should choose a card that has the lowest annual interest rate and make sure you do not get distracted by the many offers for cash back/rewards. This is because most rewards are actually only worth a couple of pennies for every dollar you spend. However, for each dollar you are not able to pay off, you could pay 18% (or more) annual interest – that’s 18 cents for every dollar. So the couple of pennies you get as rewards will not reduce the interest by very much.
Choosing the best interest rate might seem simple, but actually, this is not so — many card companies now charge a range of interest rates for a single card that is dependent on your credit score. When you apply for a card, the company might charge you 14% or they might just as easily charge you 23%, based on your credit history.
Even after you have the card, there are all kinds of reasons why the rate can change. While card companies toss around words such as ‘fixed rate’ or ‘variable rate’ around to explain their interest rates, it is best to just assume that the company can change the rate at any time for any reason.
If your plan is to pay off the bill completely each month, then look for a rewards card that gives you some type of reward, based on the number of dollars you spend. The interest rate here does not matter, since you are going to be paying off your balance.
Chasing travel rewards, such as frequent-flier miles can be very profitable, but they are not always easy to redeem, because airlines control the free seat inventory, which is very small, and numerous others are busy collecting miles and trying to use them as well. In addition, some airlines are charging customers when they redeem their miles, in some cases as high as $250, resulting in these free flights being anything but free.
How to get a good deal on your credit card
In the past 15-20 years, the credit card industry has become incredibly competitive. Companies always create seductive introductory offers to find new customers. The key to taking advantage of these offers is looking carefully at what the fine print has to say and then play by the rules.
Here are a handful of deals you should be paying attention to when you are in the market for a card.
The card company offers to pay off your debts on your old card and move the debt to their new one.
This occurrence is totally real and totally legitimate. Let’s say that you pay 15% on your debt with Capital One. Chase then offers you 0% for 6-months in an effort to reel you in. If you take the offer, Chase will pay off your CapitalOne debt and transfer that same amount of debt onto the new Chase card.
For a minimum of 6 months, you will not be charge any interest on the amount that was transferred. In the process, you are likely going to land up paying a small fee, so before you make that move, figure out how much you will actually save in interest costs, compared to the fees you are charged.
In this scenario, Chase is counting on two things:
- That you will not get anywhere near paying off the debt you transferred during the introductory period with the low-interest rate, which means they can charge a much higher rate once the initial period has expired.
- That you will miss a payment or make a late payment during the introduction period, which will lead to an increase in interest rate.
If you find yourself in this situation, you should attempt to pay off the majority of the debt by the end of the introductory period. If you are not able to get it paid off, you could always transfer the remaining debt to yet another card. However, keep in mind that if you do this too often, it may hurt your credit score. In addition, if you have old accounts that are no longer being used, keep them open, as it will help your credit score to look better.
Some cards reward you with frequent-flier miles from a specific airline, other cards let you redeem the miles at any airline. The value of the reward program depends on where you want to go, and how flexible you are able to be with your travel plans.
A card linked to a certain airline can provide great value if you travel. The trouble is, you are not always able to get your first choice of dates, and it will help you to plan your trip as much as a year in advance if you can plan that far ahead.
Still other cards let you redeem points for any airline, but generally with all kinds of restrictions. Usually, these cards are not a good choice for international travel. You might need incredible numbers of points in order for you to upgrade for a first-class trip to France. However, it is easy enough to get flights in the US, as long as you are not too picky about airlines.
Cards with annual fees
Some people just refuse to pay annual fees on principle because of the number of free cards hanging around out there. But do not be too quick to take that stance, some cards that have an annual fee also have many lucrative perks.
Do the math. Let’s say that you are anticipating spending $20,000 on a card annually, and that lets you earn 20,000 frequent-flier miles, which is likely worth a lot more than the $60 annual fee you might have to pay. So, if a card with a low-interest rate charges an annual fee, do the calculation to determine just how much you will actually save in interest charges vs. the higher-fee card you are using currently.
Keep in mind that credit cards are a competitive business, and they really don’t want you to ditch them if you don’t like their rates or fees. They will often waive the fee at least once a year. They might even offer you a better card.
Still looking for more? Feel free to check out our comprehensive personal finance guide to learn more about managing your budget and staying financially healthy.