Credit Cards: How To Choose - And Use - Them Wisely

Using your credit cards wisely is largely a matter of being informed - e.g., how much your card company is charging you for credit - and by following some simple tips for using the card.

Credit CARD Act of 2009

Known as the Credit CARD Act of 2009, the Credit Card Accountability Responsibility and Disclosure Act of 2009 went into effect on February 22, 2010. The legislation strengthens consumer protection in the credit card market and is a comprehensive reform measure to protect credit card holders in the US against unfair interest rate hikes and hidden fees. Specifically, the legislation addresses:

• Unfair Rate Increases
• Unfair Fee Traps
• Plain Sight /Plain Language Disclosures
• Accountability of Credit Card Issuers
• Protections for Students and Young People

Even with the new law in place, consumers should still be wary and shop around for the credit card that's best for them.

Examine The Card's Terms

To choose a credit card wisely, you must first review and understand the terms and features of the various cards. This can add up to very respectable savings over a period of time. In addition, you should also know how to use your cards wisely to keep your costs to a minimum. The Financial Guide explains how to achieve these goals.

Chances are you have received offers in the mail asking if you would like to open credit card accounts. Frequently, these offers say that you have been "preapproved" for the card, often with a very attractive interest rate (usually, a short-term "low-ball" rate) and with a line of credit purportedly set aside for your use (although few people ultimately qualify for the credit line in the promotional literature). Typically, these offers urge you to accept quickly, "before the offer expires." However, before accepting a credit card offer, understand the card's credit terms and compare costs of similar cards to get the terms and features you want.

Making an informed decision about a credit card is largely a matter of finding out what the actual cost of credit is under that card. Credit cards involve not only a "finance charge" - a charge for the convenience of borrowing - but usually other, less obvious charges as well.

Learn which credit terms and conditions apply. Each affects the overall cost of the credit you will be using. Due to the provisions of the Fair Credit and Charge Card Disclosure Act (1998), you can compare terms and fees before you agree to open a credit card or charge card (no interest) account. Be sure to consider and compare the terms listed below, which both direct-mail applications and preapproved solicitations must reveal.

Which card is best for you may depend on how you plan to use it. If you plan to pay bills in full each month, the size of the annual fee or other fees, and not the periodic and annual percentage rate, may be more important. If you expect to use credit cards to pay for purchases over time, the APR and the balance computation method are important terms to consider. In either case, keep in mind that your costs will also be affected by the grace period.

Annual Percentage Rate

The "annual percentage rate," or APR, is disclosed to you when you apply for a card, again when you open the account, and on each bill you receive. It is a measure of the cost of credit, expressed as a yearly rate.

The card issuer also must disclose the "periodic rate," the rate the card issuer applies to your outstanding account balance to figure the finance charge for each billing period.

Variable Rates

Some credit card plans allow the card issuer to change the annual percentage rate on your account when interest rates or other economic indicators (called indexes) change. Because the rate change is linked to the performance of the index, which may rise or fall, these plans are commonly called "variable rate" plans. Rate changes raise or lower the amount of the finance charge you pay on your account. If the credit card you are considering has a variable rate feature, the card issuer must tell you that the rate may vary and how the rate is determined, including which index is used and what additional amount (the "margin") is added to the index to determine your new rate. You also must be told how much and how often your rate may change.

Grace Period

A grace period allows you to avoid the finance charge by paying your current balance in full before the due date shown on your statement. Knowing whether a credit card plan gives you a grace period and the length of this period is especially important if you plan to pay your account in full each month.

If there is no grace period, the card issuer will impose a finance charge from the date you use your credit card or from the date each credit card transaction is posted to your account. If your credit card allows a grace period, the card issuer must mail your bill at least 14 days before your payment is due. This policy ensures that you have enough time to make your payment by the due date.

The grace period is generally misleading. The period does not start when the statement is mailed and end when your check is received, as many consumers believe. In fact, it usually starts a few days before the statement is mailed and ends a few days after the payment is received, based on certain accounting dates adopted by the credit card company.

Consequently, a 25-day grace period (a fairly common period) for paying the statement may water down to a much shorter period.

Annual Fees

An annual fee is a fee that is automatically charged to your credit card account once a year. Fees typically range from $25 to $500, depending on your credit card. The fee is for benefits that come with a particular credit card. In general, the more benefits associated with the card, the higher the fee; however, many credit cards have no annual fee so it pays to shop around.

Transaction Fees and Other Charges

A credit card also may involve other types of fees. For example, some card issuers charge a fee when you use the card to obtain a cash advance, when you fail to make a payment on time (late fees), or when you go over your credit limit (over-limit fees). The Credit CARD Act of 2009 also addresses this.

The Credit CARD Act of 2009 specifically addresses late fees and over-limit fees in that card holders must be given at least 21 days from the time of mailing to pay their bill and all late fee traps such as weekend deadlines and due dates that change each month are eliminated. In addition, the law helps consumers avoid over-limit fees because issuing institutions must now obtain a consumer's permission to process transactions that would place the account over the limit.

Balance transfer fees are incurred when balances are transferred from high-interest credit cards to lower interest cards. Fees for balance transfers are typically based on a percentage of the amount being transferred (typically 3% or 5%), with limits on minimum or maximum fee amounts. Many credit card issuers offer zero percent interest on balance transfers for the first six to 12 months that revert to regular interests rates at the end of the promotion period.

Other types of fees can include foreign transaction fees, fees for receiving a copy of monthly statements, replacing lost cards, or for using the credit card as a source of funds for overdraft protection.

Balance Computation Method for the Finance Charge

If your plan has no grace period or if you expect to pay for purchases over time, it is important to know how the card issuer will calculate your finance charge. This charge will vary depending upon the method the card issuer uses to figure your balance. The method used can make a difference, sometimes a big difference, in how much finance charge you will pay even when the APR is identical to that charged by another card issuer and the pattern of purchases and payments is the same.

Thanks to the Credit CARD Act of 2009, credit card issuers are now required to show consumers on their periodic statements how long it would take to pay off the existing balance and the total interest cost if the consumer paid only the minimum due, as well as the payment amount and total interest cost to pay off the existing balance in 36 months.

Average Daily Balance

The average daily balance method (including or excluding new purchases) gives you credit for your payment from the day the card issuer receives it. To compute the balance due, the card issuer totals the beginning balance for each day in the billing period and deducts any payments credited to your account that day. New purchases may or may not be added to the balance, depending on the plan, but cash advances typically are added. The resulting daily balances are added up for the billing cycle and the total is then divided by the number of days in the billing period to arrive at the "average daily balance." This is the most common method used by credit card issuers.

Adjusted Balance

This balance is computed by subtracting the payments you made and any credits you received during the present billing period from the balance you owed at the end of the previous billing period. New purchases that you made during the billing period are not included. Under the adjusted balance method, you have until the end of the billing cycle to pay part of your balance and you avoid the interest charges on that portion. Some creditors exclude prior, unpaid finance charges from the previous balance. The adjusted balance method usually is the most advantageous to card users.

Previous Balance

As the name suggests, this balance is simply the amount that you owed at the end of the previous billing period. Payments, credits, or new purchases made during the current billing period are not taken into account. Some creditors also exclude unpaid finance charges in computing this balance. If you do not understand how the balance on your account is computed, ask the card issuer. (An explanation of how the balance was determined must appear on the billing statements the card issuer provides you and on applications and preapproved solicitations the card issuer may send you.)

Considerations Other Than Cost

When shopping for a credit card, you probably will want to look at other factors besides cost, such as whether the credit limit is high enough to meet your needs, how widely the card is accepted, and what services and features are available under the plan. You may be interested, for example, in "affinity cards," all-purpose credit cards that are sponsored by professional organizations, college alumni associations, and some members of the travel industry. Frequently, an affinity card issuer donates a portion of the annual fees or transaction charges to the sponsoring organization or allows you to qualify for free travel or other bonuses.