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Getting a credit card can be a complicated process, especially if you don’t know where to begin. Choosing the right offer - one that fits your specific situation - can have a tremendous impact on your budget and financial wellbeing. The right choice can end up saving you hundreds or even thousands of dollars annually. Here we'll walk you through several parameters and questions to navigate through the sea of credit card offers to select the right one for you.
How To Choose A Credit Card
The first step in choosing a credit card is identifying the exact type you need. Credit cards are like any other tool – you should get them with a purpose in mind. You wouldn't buy an electric drill, if your plan was to plant tomatoes in your home garden. Credit cards operate on the same principle. First, take an inventory of your current financial habits and needs, and then decide whether you need a rewards or non-rewards credit card (like a balance transfer kind).
Can You Fully Pay off Purchases at the End of the Month?
This is one of the most important questions in finding the right card type. If your answer is anything but “yes”, look for either low interest credit cards or balance transfer credit cards. In the broadest sense, credit cards can be categorized into two groups – those that earn rewards and those that don't. If you carry a balance on your card-month to month, you should not be thinking about a rewards credit card at all. This is because any rewards you might earn will more than likely be eaten away by interest.
Note that some banks and financial institutions may choose to break down their credit cards into more specific categories. For example, it's not unusual to see "no foreign transaction fee cards" or "no annual fee" listed as categories. In these instances, the cards are not separated by card type, but rather by feature. Credit cards with no annual fee, for example, may be both rewards and non-rewards.
Choosing Between Reward Credit Cards
If you never carry a balance, then a rewards credit card is right for you. All credit cards of this type reward you with a prize or rebate for every dollar charged to them. The rates at which you earn rewards will usually differ by merchant. A select few cards will offer a fixed rate anywhere you shop. The challenge is to pick a credit card that lines up well with where you shop and spend most of your money. We have built interactive tools that let you compare hundreds of credit card offers at a glance, based on the monthly spending you enter.
The three main flavors of rewards credit cards are cash back, co-branded, and general travel rewards. Choosing between these three comes down to a matter of taste. Here is what you need to know about each type:
Cash back credit cards: These tend to be the simplest cards that provide the lowest returns on each dollar spent. For every purchase you make using a card like this, you will receive some percentage of the total back as statement credit that you can then use to pay down your bill. In some cases, you can also receive a check for the amount of rewards you collected.
- Advantages: These cards are easy to understand. You don't have to worry about redeeming points or maximizing value. Simply shop with this type of card, and apply the statement credit to your account. Another major upside of cash back credit cards is that most don't have annual fees, making them perfect for low spenders.
- Disadvantages: While easy to use, these cards only scratch the surface of what can be obtained through credit card rewards. For example, cash back credit cards typically don't have welcome bonuses that exceed $100 in value, whereas other types of cards can have ones as high as $700 - $800.
Co-branded credit cards: Some cards are partnered with a specific airline, hotel, or store. You will be hard pressed to find cards that offer higher rewards. The best co-branded credit cards will usually also come with additional parks and features great for customers who shop with their affiliated brand. For example, some airline credit cards may give you priority boarding privileges or a free checked bag.
- Advantages: These cards will provide you with the highest rewards rates, and typically net the best value for most consumers.
- Disadvantages: Rewards accumulated through co-branded credit cards tend to only be redeemable with that brand or their partners. This limits the circumstances in which you can use your awards.
Travel credit cards: the best of both worlds. Travel cards typically give you reward points that can be redeemed in a number of different ways, including statement credit (like a cash back credit card) or via transfer to airlines or hotels, making them similar to co-branded cards. In terms of value, these cards sit somewhere in the middle between co-branded cards and cash back.
- Advantages: Above average rewards rates, and flexible reward programs.
- Disadvantages: Like the old adage goes, "jack of all trades, master of none". Travel credit cards sacrifice value for added flexibility - though they are still not as flexible as the pure cash you get with cash back cards.
Choosing Between Low Interest Credit Cards
If you need to carry a balance month-to-month, your best bet will be to look for credit cards that minimize the interest you'll pay. If you don't pay your balance in full once or twice, from time to time, you can still probably profit off a reward credit card. However, if carrying a balance is something that you do more often than not, these are the cards for you. There are just two main types of low interest credit cards - general low interest and balance transfer.
Balance Transfer Credit Cards: Intended for those who are already dealing with credit card debt, and wish to pay it down quicker. This type of credit card works by allowing you to move outstanding balances from other card accounts to this one. A balance transfer credit card will waive interest fees for the first few months the account is opened, allowing you to apply the full amount of your monthly payments towards the principal balance. Such a strategy will more often than not lead to paying down a loan much faster.
- Advantages: You can save hundreds, if not thousands of dollars by getting rid of interest payments for 12 to 21 months. Over a 24 month period, for example, an individual with a $10,000 balance and 15% APR, making $500 monthly payments can save $1,349 months by using a 15 month balance transfer card.
- Disadvantages: Balance transfer credit cards aren't always optimized to produce the lowest interest rates once the 0% promotional period runs outs. Therefore, they are good to strategically reduce your debt, but are not a long term solution for those individuals who continually struggle with credit card debt.
Low Interest Credit Cards: These cards provide low interest for as long as you hold onto the account. In some cases, low interest credit cards will also often come with zero percent interest promotional rates for purchases and even balance transfers.
- Advantages: These are some of the most low-cost credit cards on the market.
- Disadvantages: If your financial situation turns around, and you begin paying off your balance in full month after month, these cards become useless since they don't provide you rewards. While the cards won't have any obvious cost to them, the opportunity cost in continuing to use them increase along with stronger habits of payments in full.
Credit Cards: When Does Paying The Annual Fee Make Sense?
One of the other big decisions to make when it comes to picking a credit card is whether or not it makes sense to get one with an annual fee. The answer will, almost always, come down to net value. If, by paying the annual fee, you receive a significant boost to what you get out of the card, it can be worth the extra investment on your part.
Generally speaking, reward cards and secured credit cards will usually be the only credit cards to charge annual fees. For non-reward and low interest credit cards, paying an annual fee makes little sense, since your aim with those products is to maximize savings - paying a fixed fee on top of the card wouldn't be conducive to that goal.
To figure out if an annual fee is worthwhile:
- Take the total amount of money you spend within a year that could be charged to the card offer you're considering
- Estimate the total value of rewards you would earn by charging the purchases from Step 1 onto the card
- Subtract from that value the annual fee
- Divide the result by the total amount of spending from step 1, and multiply by 100 to express the final result as a percentage
The final figure is what we call the "rewards rate". If this rate is below 1%, you will probably be better off choosing a no annual fee card - though you should always compare the rewards rate against other options, to see what the best deal would be for your spending habits and needs.
How Credit Score Affects Your Choice Credit Card
Credit scores are one of the biggest limiting factors in choosing a credit card. If your FICO score isn't high enough, you will be instantly denied a wide range of products. For example, the Chase Sapphire Preferred® Card is one of the best credit cards, but also requires you to have excellent credit - a score of at least 740 or better.
No matter what your credit score is, your choice of credit cards will still boil down to the same options as we outlined above - rewards versus interest. The only thing that changes is your pool of options - the lower your score, the fewer cards you can get approved for.
Secured Credit Cards
Secured credit cards are a special subset of card products intended for those with limited or damaged credit histories. If you've never had an open line of credit, or have defaulted on a loan in the past, these may be the options to look for.
In order to open up a secured credit card account, individuals are required to put down a security deposit that will double as their line of credit. These cards are intended to be a temporary option that allows users to build up their credit history. Once your score bounces back to being average, you will be able to apply for a better card that doesn't require a deposit.
Before applying for a secured credit card, double check with the issuer to make sure they report your positive credit behavior to one of the three major credit bureaus - Experian, Equifax, or TransUnion. Otherwise, all the hard work you put into paying off your debts on time, and paying any annual fees will not be building towards anything.
Just because secured credit cards are intended for those with low credit scores, doesn't mean they have limited options, In fact, the best secured credit cards can also have no annual fees, low interest rates, or even reward programs.