Credit cards are part of the modern world, they offer many benefits and perks, and can be very efficient for many activities, from daily expenses to travelling overseas.
However, like almost all financial products you need to understand credit cards to be able to get the most out of them. Failure to fully understand credit cards and how they work could end up costing you several hundred of even thousands of dollars every year.
The Quick Guide on How to Pick Credit Cards
Why Use a Credit Card
Why use a credit card in the first place, when you can use a debit card instead? Well, there are many reasons to use a credit card. The first and most obvious is the ability to spread out payment over several months, effectively letting you borrow a small sum of money without going through the formal process of getting a loan.
Think Holiday season where your expenses may exceed your income, you can use your card to pay for your purchases, and then pay the card off over the next couple of months.
Other reasons to use credit cards include making purchases online since most credit cards offer a larger degree of online payment protection than debit cards. Credit cards are universally accepted around the world, so they make the perfect travel companion when abroad.
Even for everyday spending people use credit cards that earn them points or airline miles to get a benefit from spending that they planned on doing anyway.
Credit Cards vs. Charge Cards
Now, when you start to look at credit cards, you may assume all cards are one and the same. You receive a monthly billing statement, and you pay it off if you can, or you pay what you can at the time. That, however, is not always the case.
The first significant difference is the fact that some are considered credit cards while others are known as “charge” cards. American Express is a very common charge card company. But what is the difference?
Typically, a charge card requires you to pay off the entire balance every single month. American Express and others have changed services a bit to now include credit features, but it is something to keep in mind. If a card lists itself as a charge card, you’ll know what it means.
Types of Credit Cards
The credit card market today is full of all kinds of different cards, and it can be a daunting task to select which fits best with your spending patterns and habits. To make things easier consider that all cards on the market will broadly fit into one of four categories of cards: Basic, Balance transfer cards, Purchase cards, and Reward cards.
- Basic cards
Basic cards are the most common type of cards on the market and offer a basic set of functions and will charge interest on purchases and cash withdrawals. They may or may not have an annual fee.
These cards tend to be the basic cards offered by banks and other financial institutions; they are not the best for travelling since they levy a foreign transactions fee, and tend to have a low starting credit limit.
- Balance transfer cards
These cards are squarely aimed at people who have a large balance with another card company, and wish to move their card balance to a new card.
The incentive for the client is when they shift the balance they will benefit from 0% interest for a period, typically between 12 to 36 months. They are a great option for those who have a massive credit card debt and wish to have some respite from accumulating interest charges.
- Purchase cards
These cards are designed to attract high spending customers with excellent credit ratings. They offer customers an interest-free period on their purchases. Generally, between 12 to 48 months depending on your credit score.
They are a great option for heavy credit card users, although you will need to change the card once the interest-free period is over since at this points most of these cards start to charge an interest rate on purchases that is not competitive.
Credit Card Reward Systems
The Premium end of the credit card market is dominated by reward cards. These cards let you earn some reward per dollar spent on the card. They are targeted at travellers, big spenders and people who have excellent credit ratings. Some reward systems to look out for include:
• Point System
• Travel Rewards
The Point System
A point system is a common form of compensation. For every purchase, you are given points. It may be a point per dollar or something along those lines. With the points, you can then purchase items offered by the company. This can include using points on travel or hotels. Some allow you to buy gift cards or all sorts of other things. It is a full range option that can cover just about anything you want to purchase instead of being focused on one particular area.
Who doesn’t like cashback? With this, a credit card gives you money back for purchases. Now, you need to look into the fine prints of this feature as there are many limitations. Some companies provide cash back but only on certain purchases. Others provide different cash back so, for instance, purchasing fuel gives 3% cash back while groceries only give you 1%.
Also, some companies place caps on the cashback. You don’t want to reach a cap halfway through the year, therefore check into this as well.
Travel Rewards on Co-branded Cards
With co-branded credit cards, you will receive rewards loyalty program affiliated with the credit card. Some are affiliated to airlines, and you will earn miles for your spending, that you can then redeem for airline tickets or an extra baggage allowance. Other travel reward cards are unique to a given hotel chain, such as Hilton or Starwood.
Fundamentally with co-branded cards, you earn points or miles on your spending. One of the bonuses of co-branded cards is the perks they come with; often you will earn more points when booking airfares or hotel stays, some cards even provide you with Elite status in the loyalty program.
It is worthwhile to check out the perks of each card since they can provide outstanding value. As a general rule, co-branded cards earn points quite quickly in comparison to cards offering a universal point system.
Credit Card Terminology
Before heading over to your bank or credit card company to take out an application, some key terms need to be understood so you can choose the perfect card for you.
• APR: This is the interest rate the card company will charge you for purchases that you make. In some countries, this is variable depending on your credit rating. The same card might be given to one person with an APR of 12%, while someone else will receive an APR of 28%.
• Annual fees: This is a fee the card company will charge you for the privilege of having the card. Most premium cards will have a significant fee running to several hundred dollars, while other have no fees. You need to balance out the value of the perks you get from the card against the annual fee.
• Foreign transaction fees: This is a fee, generally a percentage, that the card company will charge you for using your card abroad. If you travel a lot, you need to keep this into account since it can be quite expensive. Great travel cards often do not have a foreign transaction fee, making them ideal for use abroad.
• Cash handling charges: This is similar to the foreign transaction fee but is charged every time you use your card to withdraw cash from an ATM. This fee is not exclusive to taking money out abroad but will be charged both in your home country and abroad.
• Credit Limit: This is the maximum amount of money you can spend using your card before you have to pay it off. For example, a credit limit of $1,000 would mean you can only have a maximum balance on the card of $1,000; once you hit that balance, you will no longer be able to use your card until you have paid it off.
• Minimum Payment: This is the minimum you need to pay every month, it is not the whole outstanding balance of your card but a percentage of your balance. In a lot of countries, it is common to have a minimum payment of 5% of your outstanding balance.
A Word of Caution
Responsibility with your credit card is important. It is easy to fall into the trap of overspending and falling into debt. It is important to know what you can afford before spending the money. Have a budget and keep to it as advised by the Nomadic Matt.
Some people prefer to use cash for most transactions and only use credit cards when needs be.
This likely won’t work while travelling, but if you need help keeping a monthly budget, write everything down. Doing so gives you an actual look into what you’re spending and will help you know when to avoid using the card and putting yourself into a financial hole.
Picking the right credit card is a balancing act and requires some time and effort. You need to balance the perks and obligations of the card, against your spending patterns, income, and travel habits to find the card that suits you perfectly.
It is always a good idea to create a strengths and weaknesses analysis for every card you are considering, measured against your personal preferences before making a final decision.
Do you have a credit card? What is your goal for signing up for a credit card? Share your ideas in the comments.