Buy now. Pay later. That’s the essence of credit. For most people, credit cards can provide financial freedom to make important purchases that can be repaid later.
Credit cards aren’t inherently good or bad. Like most things in life, they are best handled with moderation and a little common sense. So, how do you choose the right credit card to fit your lifestyle?
Let’s start with some basic questions. What is the interest rate you are being charged? Can you afford the monthly payments? How much interest are you willing to pay for unpaid balances? Are there other fees associated with the card? What about rewards?
Don’t buy items you can’t afford just because the card can
Your credit card is not free money. It’s providing you with a loan. Plan for your credit card like you would plan for taking out a loan for a home or car. Be careful not to overextend your debt.
Let’s say you make a $5,000 purchase on your credit card. Assume the interest rate is the typical 18 percent and you pay $180 a month. It will take you about three years to pay off your debt—and that’s only if you don’t add to your balance.
Key takeaway #1: Have a plan for repaying your debt and paying more than the minimum balance.
Terms to know
To evaluate which card is best for you, you need to understand a few key terms:
- APR (Annual Percentage Rate) – This is the interest rate you pay on a credit card each year.
- Periodic Rates – This is the interest rate on your card for a single month. If your APR is 18 percent, your periodic rate is 1.5 percent (APR ÷ 12).
- Average Daily Balance – This is the method by which most credit cards calculate your payment due. An average daily balance is determined by adding each day’s balance and then dividing that total by the number of days in a billing cycle. The average daily balance is then multiplied by a card’s periodic rate. If you have a card with an APR of 18 percent and a monthly periodic rate of 1.5 percent, and you have a $500 average daily balance on your card, your monthly finance charge will be $7.50.
- Late Fees – If you make a late payment on a credit card, you will be charged late fees in addition to your balance and interest. Late payments can also cause your interest rate to rise.
- Annual Fees – Some credit cards charge annual fees that you must pay regardless of whether you use the card or have a balance on it.
- Promotional Rates – Some institutions offer low short-term interest rates on credit cards to customers willing to transfer their balance or open a new card. Once the promotional rate expires, a Go-To rate will kick in, so know what that rate will be
Key takeaway #2: Understand a credit card’s key terms so you understand the full costs.
The fun part: rewards
To attract your business, many credit card companies offer rewards programs. The rewards might include things like cash back, airline miles, gift certificates and more. Rewards can be a great perk for cardholders.
Think about the kinds of rewards that make sense for your life. If you’re a regular traveler, airline miles or hotel savings might be ideal. Then weigh the benefits of the rewards program as part of the whole package.
Key takeaway #3: Credit card rewards can be a fantastic way to save on purchases you would normally make anyway.