A Crash Course in Credit Cards
With so many types of credit cards on the market, it’s more important than ever to find the right card for you. Since credit card features are fairly easy to compare and contrast in a grid format, it should be easy to figure out what the best card is, right? But, as it turns out, there is no such thing as the “best” card for all credit card users. What determines the best card for you is the type of spender you are, how often you pay off your balances, and how you like to be rewarded.
Determine Your Type
There are three typical types of credit users: the revolver, the transactor, and the “dormant” account. If you already have an open credit card, reflect on how you’ve used (or not used) that card. If you’re considering your first credit card, think about how you handle bills and your shopping habits.
A revolver, named for a revolving credit line, carries a monthly balance. Revolvers tend to make minimum payments toward both the principle amount owed and accrued interest. By making minimum credit card payments, this often helps the card holder meet their other monthly budgets. Because of this, revolvers pay more over time interest fees, but are able to space their payments apart and make credit usage more affordable in the short-term.
On the other hand, a transactor pays their balance in full and by the due date every month. By not carrying a balance, transactors do not pay interest or late fees. A transactor does not charge anything to their card that they are unable to pay off quickly, often treating their credit card like an interest-free one-month loan. This way, transactors are able to earn rewards and contribute to their credit score without any additional fees or prolonged debt.
A dormant or inactive account is one in which there has been no activity for a long period of time. Card issuers may close the account due to disuse, which may affect credit score and retract access to that card’s benefits.
Choose Reward or Interest Rate
Active users, meaning transactors and revolvers, can benefit from having a card that complements their spending style. By using existing money habits and a tool that rewards those habits, credit card users are able to stay smart about debt and earn cash, bonuses, and even travel.
Someone who heavily loads charges onto their card could earn significant rewards on a cash rewards card, especially when taking advantage of special promotions on purchases like gas or restaurants. While 1, 3, or 5% cash back may not seem like a lot on a small transaction, strategic users can use their cash rewards card as an extra discount on every purchase.
For those who carry or transfer a high balance, a low interest rate can help save money over time. While not necessarily earning money back, a low interest rate helps keep payments low and prevents debt from snowballing uncontrollably. Plus, points are earned according to dollars spent, so a patient user can accumulate mountains of points over time by simply using their card as normal. Points can be redeemed for gift cards, household items, electronics, movie or plane tickets, and more.
While it’s not a hard and fast rule, more often than not, transactors choose a higher-interest, cash back card and revolvers prefer a low-interest, reward points card. The transactor spending style lends itself well to earning maximum rewards while avoiding the higher interest rate, but this type of card usage requires an alert user who pays their card in full and maximizes cash back percentages. On the other hand, revolvers are able to use their slow and steady approach for a low-pressure credit line that makes credit affordable and offers exciting rewards with no extra effort from the user.
Credit as a Spending vs. Earning Tool
While getting paid to use your credit card may seem alluring, don’t let interest nullify the reward. Cash back cards may have higher interest rates, which can quickly sap all of your earned cash back if you aren’t careful about paying the balance in full.
For a $1,000 purchase with an average 15% APR:
- With $25 payments, it would take you 54 months (4.5 years!) to pay off, with $355 in interest.
- With $50 payments, it would take you 23 months (just under 2 years) to pay off, with $147 in interest
- With $90 payments, it would take you 12 months to pay off, with $78 in interest.
To have earned that $78 in cash back in the first place, you would have to spend:
- $7,800, earning 1% back
- $2,600, earning 2% back
- $1,560, earning 5% back
Be mindful when spending. Don't over-charge just to earn rewards. A hefty interest payment from a high balance can overwhelm the cost of the reward item earned by making the charge in the first place.
Pay Attention to Fees
Even the most careful of credit card users can end up paying extra in fees, whether unexpected or as part of owning the card. Even when paying balances in full to avoid paying interest, additional charges like annual fees, balance transfer fees, late fees, foreign transaction fees, and others can be a drain on your wallet. The best way to avoid these fees is to choose a card with the fewest of these fees built in as part of holding the card. There are plenty of card options that don’t charge a yearly fee and other services like balance transfer are used infrequently, if at all.
However, if you deem that the rewards outweigh the fees, don’t shy away from choosing a card if you think it’s the right fit for you. Watch the card closely as you use it and make sure you aren’t spending more than you’re earning or saving.
Credit Cards and Credit Score
Finally, be aware of your credit card’s effect on your credit score. This piece of plastic can be a powerful tool to build, repair, or unfortunately, damage credit. Your credit score is comprised of the following approximate factors, all of which can be influenced by having a credit card:
Payment history (35%) – the record of payments you’ve made on all loans and lines of credit. Revolving loans, like credit cards, tend to weigh more heavily and are considered both collectively and individually. Making consistent, timely payments is one of the best ways to improve your score, though severity and frequency is taken into account for missed or late payments. Because this is the largest percentage when calculating credit score, developing good habits is a simple way to get a boost.
Credit utilization (30%) – the percentage of your available credit used. If your credit card limit is $5,000 and your current balance is $1,250, you are utilizing 25% of your available credit on that card. Staying below 30% total credit utilization is advisable, but the lower your utilization percentage is, the better your score. Maxing out is considered irresponsible credit usage, so use discretion when closing inactive accounts. Your available credit will go down with one less line.
Length of history (15%) – the amount of time each account has been open and time since the most recent activity. For anyone new to credit, this factor may seem out of your control, but the key is to begin building credit as early as possible. For long-term credit users, maintaining activity on older accounts is the key to success.
New credit (10%) – the amount of new debts added in the past six to twelve months. Opening multiple accounts in a short period of time can hurt your account, as the borrower may appear to be in financial trouble. But for those with a lower score, the small decrease from opening a new line can lead to a better score in the future by lowering credit utilization and a history of on-time payments.
Credit mix (10%) – the variety of credit products in your portfolio. As a borrower, this is proof that you are able to handle and pay back various types of credit. Of all types of debt, you are most likely to have multiple credit cards, which can actually be considered a good thing in this category, as those with no credit cards are considered to be higher risk than those who have shown good credit card management skills.
Master Your Card
Credit cards are a powerful tool that can provide access to wants and needs in present and the future. Know your credit card and use it to its full potential to maximize rewards and minimize spending. If you’re in the market for a new card, American Heritage Credit Union has low-interest and cash back card options with special promotions! Enjoy special low rates or extra cash back and let us help you through the holidays.