Credit cards serve as a valuable financial tool when handled wisely. They can provide assistance during temporary financial crises and contribute to building a robust credit history, crucial for securing significant loans like mortgages. However, misuse can swiftly lead to substantial debt.
As reported by USA Today, American credit card debt has soared to over $1.1 trillion, with an average balance of $6,200 per cardholder. For households with multiple cards, these balances accumulate rapidly. Understanding credit card functionality and selecting one carefully can prevent falling into common pitfalls. Here are five essential factors to ponder when seeking the right credit card for your needs.
Annual Fees
Most credit cards come with costs beyond just the interest on balances. One common expense is the annual fee, which can range from a nominal $25 to a hefty $500, depending on the card’s perks. Typically, the more benefits a card offers, the higher its annual fee. This charge is automatically billed to your account each year and accrues interest if not paid promptly.
Credit cards with annual fees often include reward, premium, or secured cards. However, there are fee-free options available, which usually make more financial sense. If you opt for a card with an annual fee for the enhanced rewards, ensure that the benefits outweigh the cost. Calculate whether the rewards you earn annually exceed the fee; otherwise, you may end up losing money. For instance, if your card charges a $129 annual fee but you only earn $100 worth of rewards each year, it’s a losing proposition.
Minimum Payment
Understanding the minimum monthly payment on your credit card is crucial for responsible management. This requirement mandates that you pay a specified minimum amount by a certain date each month. Typically, the minimum payment is calculated as a percentage of your outstanding balance. Therefore, the higher your balance, the larger your minimum payment will be.
You can find your card’s minimum payment printed on your monthly statement or by logging into your online account. Familiarizing yourself with this figure and the consequences of missing it will help you avoid unnecessary issues down the line.
Penalties and Charges
Failing to meet the minimum payment on time can lead to significant penalties, including increased interest rates, loss of rewards, and potentially, card cancellation.
Penalties associated with credit cards are serious and can quickly escalate financial troubles. They extend beyond missed minimum payments to include various transactions like balance transfers, cash advances, and even credit limit increases or phone payments.
Late payments or exceeding your credit limit can trigger penalty charges, often manifesting as higher interest rates. For instance, your standard 18% interest rate could soar to 26% with a cash advance, or even become a permanent hike if you surpass your credit limit.
Understanding the implications of penalties is essential for avoiding financial pitfalls. When selecting a credit card, prioritize those with minimal penalties and reasonable or waived fees. Ensure you carefully review the terms and conditions to comprehend penalty structures and associated charges.
Rewards
Credit card reward programs vary significantly in their offerings. While some programs deliver substantial benefits, others may merely incentivize increased card usage without providing significant rewards. Typically, these programs fall into three main categories: cashback, points, or miles.
Cashback
Keep in mind that cash rewards might not always be dispensed in cash. Many programs convert cash rewards into a credit on your account, which might not count as a payment, necessitating a separate minimum payment. Alternatively, some cashback programs offer redemption options like gift cards with affiliated merchants. While rare, certain credit card companies may transfer accumulated cashback directly to your bank account.
Points and Miles
Point rewards typically operate by offering one point for each dollar spent, with points redeemable for merchandise through the program’s online shopping platform. Additionally, points may be exchangeable for gift cards, though certain restrictions, such as expiration dates or value limitations, may apply.
Miles or travel reward cards function by granting miles that can be utilized for various travel expenses like airline tickets, rental cars, or hotel accommodations. Both the accumulation rate and redemption requirements for miles can vary between credit cards.
While credit card rewards can offer advantages, navigating them can be complex. It’s crucial to understand the redemption process and any limitations associated with it. Consider your likelihood of utilizing the rewards effectively; there’s little point in paying a high annual fee for air miles if you rarely travel. Ultimately, opt for a reward program that offers tangible benefits aligned with your preferences and usage patterns, without burdening you with excessive costs.
Interest Rate
The most critical factor to consider when selecting a credit card is its interest rate, also known as the Annual Percentage Rate (APR). This rate represents the cost of borrowing on the card, and unless you settle the entire balance monthly — which is highly recommended — you’ll accrue interest charges.
In the United States, credit card interest rates average around 14.1%, as per a 2018 Federal Reserve report. However, some cards can impose rates as high as 30%, particularly on balance transfers, cash advances, and other transactions.
When comparing credit cards, it’s essential to scrutinize their interest rates. Assess the APRs across various card types and opt for the one that offers the most cost-effective ownership and usage. Be aware that certain cards may provide a 0% introductory interest rate, usually lasting for the first 12 to 18 months. While this grace period can be beneficial for avoiding interest charges temporarily, it’s crucial to understand when this promotional rate expires and what rate it will revert to afterward.
As a general rule, prioritize credit cards with the lowest APR or interest rate. Doing so can yield significant savings, especially if you’re unable to pay off the entire balance each month.