Choosing the Right Credit Card
May 4th, 2018 by Anchor Bay Capital's Investment TeamDo you have a balance on a credit card that is aggravating you? You are not alone. The U.S. as a whole is faced with a huge stockpile of credit card debt. As of 2017, the average balance for every household utilizing a credit card was $15,983[1]. With credit being so accessible and our increasing appetite as consumers, it is obvious that without discipline, buying on credit can turn into a problem. I once heard an individual explain that they did not use credit cards because their father said it was like taking out a mortgage when you buy your clothes. If you feel that you lack the discipline to pay off a balance in full each month, then I recommend that you spend on cash or a debit card. You should remove your credit cards from your wallet or phone and only use them in an emergency. We will discuss how to get out of accumulated debt in another post. However, this week, since credit cards have become almost essential for spending in our digital world, I would like to discuss how to choose an effective credit card.
Choosing the right credit card
The market for credit cards is huge and there are tons of options for you to choose from. Credit cards may all look pretty much the same, however, if you really look at the details there can be drastic differences in the benefits and penalties associated with each card. I decided to write this post because as I have worked with clients, I have seen people utilizing cards that are just a really bad deal.
First, make sure to understand your spending needs and habits
An important reason to utilize a credit card is to start building your credit history. I remember when I went to buy my first car, and I walked away with a pretty poor deal and a higher than average interest rate simply because I did not have enough credit history. So establishing a record of timely payments with a card can have an important positive impact on your finances, but you need to make sure that you have the right tool for the job. Are you acquiring a credit card to use as your daily tool for spending? Is it just for emergencies? Are you transferring a balance? Determining your needs from the onset is important to narrow your selection. If you’re going for a credit card to use only during emergencies, it makes no sense to opt for a reward card with their often bloated interest rates; a low-interest no-frills card would be a better option. Conversely, if you intend using the card as your daily driver, cards with generous reward plans and increased credit limits are the best bet. There are also cards designed specifically for balance transfers offering extended zero interest periods with little other benefits.
Credit card basis – APR
The Annual Percentage Rate (APR) of a credit card is a measure of how much is surcharged as interest on all payments you make using your card in a given year. This number really does matter. I have spoken to people who say they pay off their card every month, so the interest rate is of no concern. But here is what you need to understand. Your APR compounds daily. This means that the credit card company calculated your balance on a daily basis and applies interest. Most cards include a grace period so that if you make your payment within this grace period, you avoid paying this interest. However, if you slip up or your payment falls outside of the grace period you will get stuck with the compounded interest on your purchases.
APRs can be fixed or variable. It goes without saying that fixed rates are generally considered better since you get an overview of what you will be paying as interest in the long run. The best fixed APR is the lowest APR. I recommend checking out the cards offered by your local credit union. I have found that these cards typically carry a lower APR than your standard retail cards and most of the time offer the same benefits. Sometimes you even get better deals on your APR if you have certain balances in savings at these institutions.
Pick a card with a higher limit
Once you’re approved for a credit card, the issuer will specify a credit card limit – the amount of money you’re allowed to spend using the credit card. This is in part set with your overall credit score. However, it differs from issuer to issuer. Your credit score is greatly affected by your credit balance to credit limit ratio. So, a credit card with a higher limit does not only bolster your credit score but also keeps you from the fringes of overshooting your spending limit. If you are using your card for daily spending and you also put a large unexpected expense on your card, you need the largest buffer you can get between your balance and your limit.
Keep a keen eye on fees and penalties
The truth is credit card issuers are out there to make as much money from you as you allow them to. It’s why there’s an assortment of fees and infractions (punishable by additional fees) waiting to be triggered. The typical issuer will charge you often inflated sums for anything from cash advances, foreign transactions, convenience checks, balance transfers, requests to increase credit limit and the customary penalties for late bill payment and overshooting your credit limit. As with APR, it’s your job to sift out the issuer with the cheapest and most reasonable array of fees. Two of the most common excessive fees that I see are:
- Balance transfer fees: It is easy to get enchanted by a zero interest offer for a balance transfer. Just make sure that you calculate the fee that you’ll pay for the transfer. In some cases, you could pay another 8 to 10 months of interest on your current card to break even with the flat balance transfer fee.
- Annual Fee: Many cards charge an annual or membership fee. Make sure you clearly understand what you are receiving for this fee. With all of the cards out there that do not carry annual fees, I find it very difficult to justify these fees.
The tricky case of rewards
I love my credit card rewards! I have paid for entire vacations utilizing just my credit card points. It is clear that if you have a good rewards program and you spend on your card monthly, these points will benefit you. However, do not allow your cravings for freebies overcome your sense of reason. Cards typically offer rewards programs in exchange for higher interest rates, so If your card carries a balance every month, it’s probably in your best interest to avoid reward cards. It’s also important to know that rewards programs are not all created equal. Make sure you pick a program that provides benefits that match your needs. The most important thing to remember is not to be enticed into a card every time a reward is offered. It pays to use one card with a good rewards program. Check to see what type of travel rewards and shopping rewards you get with your main card before jumping into a special offer.
Stay in control
No matter what card you utilize, your success depends on your discipline. Make sure to review your spending at least twice a month to make sure that you are on budget and that you are within your means. You can utilize online tools like our client portal so that you can set up budgets that monitor your transactions and alert you when you are over spending. If you have dug yourself into a hole, remember you are not alone. Make sure that you have a support team. We are happy to assist you. Our financial planning services can help you review your debt and choose the right strategies to pay it off efficiently.
[1] https://www.nerdwallet.com/blog/average-credit-card-debt-household/