Credit cards get a bad rap for creating financial problems for their users. However, to paraphrase the NRA, credit cards don’t bankrupt people, people bankrupt people.
Before you apply for a credit card here are some things you should know.
Get a copy of your credit report
Every consumer is entitled to receive a free, annual copy of her credit report. To get it, visit the website www.annualcreditreport.com. (Note that there is a paid service with a similar name involving the word “free” that, ironically, is not free.) Knowing how your credit looks will help you understand how you might be evaluated. If your credit report shows any late payments, your credit score is likely to be impacted. If your credit report shows judgments, foreclosure or bankruptcy within the last seven years, you will have trouble obtaining a credit card.
Applying for a credit card impacts your credit
If you are planning to buy a home within the next 12 months, do not apply for a credit card. The mortgage underwriters will assume that you are either effectively borrowing your down payment or that you are planning a spending spree after you buy your home.
Credit cards vary dramatically
All credit cards are not the same. In fact, they have dramatically different terms. Some offer grace periods where if you pay the balance in full, you pay no interest. Others, often charging lower interest rates, charge interest on everything with no grace period. Interest rates vary widely. Cards with rich benefits, miles, points and other rewards often feature the highest rates of interest.
BankRate.com offers a screener
You can use the BankRate.com screener to identify cards that offer the features you want most.
Rewards have value
When you make purchases, you can be rewarded for that in significant ways. Many people spend $25,000 per year or more on a credit card. That kind of spending can result in significant cash back, frequent flyer miles or other perks. Be sure to choose a card that offers something you want (everyone can use cash). For instance, I travel a lot so I use one card that gives me frequent flyer miles and another card that gives me points toward free stays at my favorite hotel chain.
Know how you’ll use your card
If you will pay off your balance each month (really and truly) then you don’t much care about the interest rate on the card so long as there is a grace period during which you’ll pay no interest when you pay off the entire balance each month. On the other hand, if you know you’ll be carrying balances consistently, finding a card with the lowest possible rate is a high priority — trumping any rewards program. The difference between paying 24 percent and 8 percent on your $5,000 balance is $800 per year — much more than the value of mileage rewards or cash back.
Beware of balance transfer teasers
Most balance transfer teasers are structured to segregate the balance transfer funds and pay them down first as you make your payments, subjecting the remaining balance (new charges on the card) to a much higher rate. Imagine transferring $5,000 to a zero rate credit card and making payments of $500 per month. If you are charging $500 each month, your balance transfer will be recorded as completely paid off in under a year, but your balance will be above $5,000 because of the interest charged on your new charges. Be sure to watch for the interest rate on new charges.
Credit cards are an important tool that can make your money management much easier and your life safer. Be sure you know how to manage your credit card usage before you apply so you get the right card and stay out of trouble.