Credit cards are a convenient financial tool. They are also a huge money maker for credit card companies. Whether or not you or the credit card issuer comes out on top can depend on how much you know about how credit cards work.
Credit cards generate billions in revenues in the United States, but you can minimize your contribution to those revenues if you know the following seven things about credit cards:
1. Competitive interest rates are out there
Credit card commercials are a staple of television broadcasts. Your mailbox may be full of credit card offers. It's also hard to visit the bank or go shopping without being offered a credit card.
One thing most of these pitches have in common: they don't mention the interest rate you will be charged. Legally, this has to be disclosed when you sign up for a card, but often that disclosure is treated like an afterthought. By that point, you have probably already started the process of applying for the card.
But remember the credit card market is very competitive, with plenty of opportunities to save money by finding a lower rate. Don't choose a credit card just because an ad got your attention or someone happened to offer it at the right time. The only way to be sure of getting a good deal is to shop around and compare rates.
2. The advertised rate may not be the rate you get
Credit card companies have different interest rate tiers. The lowest rate tiers are available to customers with the best credit, while those with lower incomes or weaker credit histories are assigned a higher rate tier.
So if you have less-than-perfect credit, pay attention to the higher end of the rate range rather than the lower end, and get a quote on which rate would apply to you before you sign up for a card.
3. Watch out for credit card fees
A tricky thing about comparing credit cards is that besides having different rates, some have fees and some don't. The fees can be significant enough that a low interest rate that comes with a fee may not be as good a deal as a slightly higher rate with no fee.
To figure this out, you have to estimate how much of a monthly balance you are likely to keep on your credit card. Then you can project how interest rate expense will compare with the fees. As a rule of thumb, if you tend to keep high balances, you should focus on finding a card with a low interest rate. If you keep little or no balance, then interest rates are less relevant and you should focus on avoiding fees.
4. Rewards may come at a price
Rewards credit cards typically charge higher interest rates than non-rewards cards, so if you keep high balances on your card the extra interest cost could outweigh the value of the rewards.
On the other hand, if you pay your card balance off in full every month, you can reap credit card rewards without ever paying the extra interest - and that really is rewarding.
5. When it comes to rewards, cash is king
Rewards are offered in many different forms, from travel miles to merchandise to cash back. In most cases, when you calculate the economic value of rewards programs, they work out to be pretty much the same. All things being equal, cash back is the best form of reward. It gives you the flexibility to spend your rewards however you like - or even take the radical approach of saving the money.
6. Minimum payments maximize credit card company profits
Minimum monthly payments seem very reasonable because they are generally quite low compared to the balance owed, but they are so low because they are designed to make you pay interest over the longest time possible. Make more than the minimum payments, or else you will be maximizing the interest you pay.
7. Zero-percent balance transfer does not always mean free
These are attractive deals to people who carry long-term balances and want to reduce the interest they are paying, but watch out. The zero-percent interest rate is usually temporary. There is often a fee for transfers that can outweigh the money you would save while the zero-percent rate was in effect.
Knowledge is power. Using your knowledge to shop for and use credit cards can give you the power to stop your hard-earned dollars from contributing to the already-huge credit card industry earnings.
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