Choosing a Credit Card: What You Need to Know

Before you sign up for a new card, make sure you understand the card's important credit terms. That way, you can recognize (and avoid) traps when choosing and using the card.

Credit cards are convenient. But if you don’t understand your card's terms and conditions, you could easily dig yourself into a financial hole. Read on to learn what you need to know when choosing a credit card.

Credit Card Terms and Conditions to Know

If you're in the market for a credit card, you can save yourself lots of money by shopping around and then picking the card with the features that best fit your needs. First, you should learn about the standard terms and conditions associated with most credit cards.

Annual Percentage Rate (APR)

Credit card companies must disclose the interest rate as an annual percentage rate (APR). The APR is the percentage you’ll pay in interest each year, assuming you carry a balance. Credit card companies charge different APRs and have various terms based on the individual applicant's credit report or score.

Each month, if you haven't paid the balance in full by the due date, the credit card company applies the APR to the account balance to compute the finance charge for that month. The finance charge is the dollar amount you pay to use the credit.

Because federal law—the Credit Card Accountability Responsibility and Disclosure (CARD) Act of 2009—requires that the APR be calculated in a standard way, it allows you to compare the cost of credit among various credit card companies using a single yardstick. The APR is the best indicator of the actual interest you will pay. If different APRs apply (for example, to balance transfers or cash advances), the credit card company must disclose those as well.

If a credit card company offers you a card with a less than stellar interest rate, it might be required to give you information about its decision. In any event, you can ask the credit card company why your APR is so high, and you can always get your credit report and figure it out yourself. Armed with information, you will be in a good position to figure out what you need to do to improve your credit history and get a better APR down the line.

Grace Period

A “grace period” is the interest-free period between the purchase date and the bill's due date. It's usually available only to those who don’t carry a balance. Grace periods generally don't apply to cash advances or convenience checks, which begin accruing interest right away, often at a higher rate than purchases.

Computing Balance for Purchases

Different credit cards calculate finance charges differently, like by using the daily balance method, adjusted balance method, previous balance method, or average daily balance method. A credit card offer must explain which way the company uses to calculate the balance on which it applies the APR.

Annual Fees and Transaction Fees

Credit cards often charge various fees, like annual fees and transaction fees.

  • Annual fees. Some credit card companies charge you a yearly flat fee—in addition to interest and other charges—for using their card. Some don't.
  • Transaction fees. The company must disclose any fee that's imposed for using the card to make purchases, balance transfers, or cash advances.

Shopping for a Credit Card: Avoiding Credit Card Traps

If you’re not careful, credit cards can also trap you in debt for years. Some, but not all, credit cards have one or more potentially harmful features, and certain cards have worse terms than others.

Different and Varying Interest Rates

Generally, you want to choose the lowest and most stable APR that will apply to how you plan to use the credit card. For example, if you plan to carry a balance, look at that APR. Even a small difference in the APR can make a big difference in how much you’ll pay.

Here are some guidelines when considering APRs:

  • If you won’t ever carry a balance on your credit card, then the APR isn’t important. You won't ever pay interest.
  • If you don't pay your bill in full each month, the APR is crucial. The lower the APR, the better.
  • Watch out for "introductory rates," which are also called a "teaser rates." If conspicuously disclosed, credit card issuers can increase teaser rates after six months.
  • Make sure the advertised rate applies to you. Sometimes it only applies to certain people, such as those earning a high income. Those who don't qualify get a higher rate.
  • Card issuers generally can't raise your interest rate for the first year after you open the account. But some exceptions apply—like when a variable rate changes, a promotional rate ends, or a required minimum payment is over 60 days late—so be sure to read the fine print.
  • Some APRs vary monthly based on a benchmark like the prime rate. The application or solicitation must disclose that the rate may vary and state how the rate is determined.

Over-Limit Fees

Credit card companies can charge you over-limit fees if you opt in, which means that you agree in advance that the credit card company can allow transactions putting your balance over the credit limit. But if you don’t opt in, the company can’t charge you this kind of fee even if the company processes a transaction over your limit.

So, the best strategy to avoid over-limit fees is not to opt in. If you do so by mistake or change your mind, you can revoke this agreement at any time. Though, fees would still apply to over-limit transactions already processed.

High Penalty Fees and Interest Rates

Credit card companies routinely charge penalty fees for late payments and payments returned for insufficient funds. The CARD Act limits these fees to the actual amount the violation cost the company, or to a maximum of $29 for the first violation and $40 for a second violation (2020 figures) if it occurred within six billing cycles of the first violation. If you occasionally pay late or sometimes have insufficient funds, compare how much different companies charge for these fees.

In addition, if you go over the limit, your payment is returned, or you have one or more late payments, your interest rate might go up. The default rate then applies to any new balance, not just to the late payment. After a credit card company raises your APR, it has to reevaluate it every six months, but you could still end up paying the default rate for quite a while. And if you’re more than 60 days late with a payment, the default rate can apply to the outstanding balance as well (though you usually can get it reduced on the outstanding balance by making the next six payments on time).

High Cash Advance Fees and Interest Rates

Getting a cash advance or using the convenience checks that a card issuer sends you can be quite costly. Credit cards tend to charge a fee of up to 5% (or a minimum amount like $5 or $10) for taking a cash advance, though some waive the fee on convenience checks. Also, the APR is normally high—around 25%—for cash advances.

Annual and Other Fees

Again, some credit cards charge annual fees, while others don’t. Generally, you should look for one that doesn’t require a yearly fee. But if you plan on carrying a balance, a card with an annual fee but a low interest rate might be less expensive than a card with no annual fee but a high interest rate.

Also, beware of other fees. New fees seem to pop up all the time.

No Grace Period

If you don’t get a grace period, the card issuer can impose a finance charge from the date you use your card or from the date each transaction is posted to your account—even if you pay your bill in full each month. So, if you pay your account in full every month, make sure you have a grace period.

Costly Balance Computation Methods

Different cards might appear to offer the same APR, but the balance computation method might not be the same, which could cost you very different amounts. Again, credit card disclosures have to tell you which way the company uses to determine your monthly charge (the finance charge). The method that results in the lowest balance each month will be the cheapest card for you.

Enticing Rewards, Points, Discounts, and Other Perks

Don’t get lured in by cards that offer bonuses, let you design the card, or give you discounts. If you will pay high interest or could get hit with high fees of various sorts, or if the card uses one of the worst computation methods, you’d be better off without the perks.

How to Avoid These Traps: Read the Terms and Conditions

Credit card companies must display their credit agreements online. When you go to a credit card company’s website, look for a link that says “Terms and Conditions” or “Pricing and Terms” (you might have to hunt around). Use this information to compare terms between cards.

When you get a credit card application or pre-approved solicitation, the company has to disclose certain terms of the agreement. They could be tucked away on the back of one of the documents, so you could have to do some searching to find them.

The Bottom Line

When shopping for a new credit card, be sure to look for a card that matches your needs. If you think you might carry a balance, look for the card with a low APR even after any introductory rate expires. If possible, get a card with a fixed rate rather than a variable rate. If you sometimes pay late, compare fees for late payments. Avoid cards with high start-up, annual, or other periodic fees, and, of course, don’t agree to allow over-the-limit transactions.

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