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Choosing the Right Credit Card
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Credit cards have a bad reputation – and with good reason. The exorbitantly high interest rates make credit card debt extremely difficult to pay back. However, with choosing the right credit card, you can turn that plastic card into a very useful asset, providing you with low-interest financing, great rewards, and even cash back at the end of the year. However, it is critical that you carefully review the fine print to ensure that you are choosing the right credit card – and not one that will throw you into a vicious cycle of debt.
Understanding your credit card needs
Choosing the right credit card is dependent upon how you will use the credit card and what your financing needs are.
If you do not plan on carrying your balance over to future billing cycles, then you should find a credit card that offers cash back, no annual fee, and a longer grace period.
If you will not pay your balance in full each billing cycle, then choose a credit card that has a lower interest rate; the closer you can get to 7%, which is the lowest end of the spectrum, the more money you will save.
If you will need cash advances from your credit card, then it is important to find an issuer that has low transaction fees, as well as a reasonable APR. Considering that some credit cards will charge you a higher interest rate for cash advances, reading the fine print is important.
Choosing the right credit card fundamentals
Credit cards utilize industry terms – often specifically to confuse the consumer. It is important that you understand the jargon to ensure that you are choosing the right credit card. The credit card terms will determine whether or not this financing will work in your favor or against your financial standing.
Annual Percentage Rate (APR): The APR is the most important element of choosing the right credit card, if you plan on carrying balances over from month to month. If you do not pay off your charges every month, then you will often pay exorbitant interest rates. Understanding how much your APR is critical to choosing the right credit card. It is important to shop around for reasonable interest rates; generally, APR will vary between 7% and 36%. Any rate above 20% is not a financially intelligent choice. Your credit card issuer must also disclose your “periodic” rate, which is the interest charge you must pay for each billing cycle.
Variable APR: Depending upon your credit card terms, your lender may change your APR when economic variables or market rates change. These “indexes” will impact your APR, either lowering or raising it. If you do choose a variable rate APR credit card, then your lender must divulge to you how the APR fluctuates, and how that change is calculated. Generally, it is not advised to choose a variable APR because you could pay much higher interest rates in the long run. Instead, select a fixed APR credit card, and you always have the option of calling to ask for an APR deduction, should the market rate fall.
Different Purchase APRs: Some credit card companies charge different APRs, depending upon your purchases. Typically, APRs for cash advances are higher than the regular APR for your credit card transactions. Again, if you need cash advances, choose a credit card that offers a lower APR on these transactions, or perhaps even matches your general purchase APR.
Tiered APRs: Credit card issuers may charge you tiered APRs, placing your balance into a higher interest rate once it reaches a certain threshold. If you may carry your balance over to future billing cycles, find a credit card that offers the same APR, regardless of your total balance value.
Introductory APR: Many credit card companies utilize a low APR to entice you to sign up for their card; however, keep in mind that an introductory APR expires quickly, and then you may be charged an exorbitant standard interest rate. Make sure you understand what your regular APR is after the introductory period ends.
Annual Fees: Read the fine print carefully to determine if you are being charged an annual fee. Many credit cards charge an annual fee, generally ranging from $25 to $100. Partially, the annual fee can depend upon the “perks” you want; for example, gold or platinum credit cards can charge an additional $100 to $500 in annual fees. There are certainly other credit cards that have no annual fee, saving you an extra $100 per year.
Balance Calculation: How your credit card issuer calculates your balance plays a large role in how much interest you must pay. Generally, you want to choose a credit card that calculates interest based upon adjusted balance, as this is most advantageous for you – and not the credit card company. For example, the following credit card has the exact same terms – with the exception that one issuer calculates interest based upon the adjusted balance, and the other utilizes the previous balance.
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Previous Balance
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Adjusted Balance
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Monthly / Periodic Rate
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1.5%
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1.5%
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APR
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18%
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18%
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Previous Balance
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$1,000
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$1,000
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Payments
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$800
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$800
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Finance Charge
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$15
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$3
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Grace Period: If you plan to pay your balance in full, be sure to choose a credit card that offers a “grace period,” which is generally 30 days. Within this grace period, you do not have to pay interest rates or fee charges, if you pay your balance in full at the due date. Even if you plan to carry over balances, you should still look for a card with a grace period to reduce the fees that you will accrue.
Evaluating the types of credit cards
The sophistication of credit cards provides you with a myriad of options, and knowing the benefits and advantages of each helps in choosing the right credit card.
Secured vs. Unsecured
Fundamentally, there are two major types of credit cards: secured and unsecured. Whereas most credit cards are unsecured, secured cards are an excellent choice for those who have poor credit, or who have difficulties spending within a certain limit. With a secured credit card, you deposit monies ahead of time, and your maximum spending limit is based upon how much money you have already given to the issuer.
On the other hand, unsecured credit cards are not backed by an initial deposit of money; thus, you typically would have a larger credit limit, but at the same time, it is critical to carefully manage your spending.
Rewards vs. Cash Back
Most credit cards now offer a bonus feature to entice customers to sign up with the issuer. Some will offer frequent flyer miles with a particular airline, while others provide 1% - 3% cash back on certain purchases at the end of the year. Typically, the credit cards that offer “rewards” charge an annual fee, so it is important to read the fine print to determine if the perks outweigh the costs.
Generally, credit cards that offer cash back are the best deal; you have the freedom of putting that money in your savings account, paying off any balance, or purchasing whatever goods you would like. In addition, with some cards offering 1% cash back on all purchases, as well as 3% back on gasoline, the cash rewards are very lucrative. However, be sure to read the fine print to ensure that you are choosing a credit card that does not put a maximum cap on the cash back rewards you can earn.
The “Perfect” Credit Card
When you are choosing the right credit card, you can use this general yardstick to see how the offer measures against an “ideal” credit card:
No annual fee
Fixed, low APR (with 7% being the lowest)
Cash back rewards without a maximum earning cap
Adjusted balance calculation
Long grace period
Choosing the right credit card for you requires asking questions and reading the fine print. However, the time you invest in choosing the right credit card will pay off – literally in the thousands – for lower annual fees and APR costs, as well as better rewards.
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