The ABCs of Credit
Do you know your ABCs when it comes to credit? If you don’t, you could end up paying more than necessary or missing out on valuable rewards.
Your ABCs are the basic building blocks when you learn how to read. But when it comes to credit, you also need to know your ABCs -- otherwise you could end up paying much more on your credit card accounts or missing out on valuable perks and rewards.
Not sure what the ABCs of credit are? Read on to find out.
Image source: Getty Images
A is for APR
The A in the ABCs of credit is the single most important credit factor if you’re carrying a balance on your cards. A stands for APR, or annual percentage rate. It’s the amount you pay to borrow, including both interest and fees. It’s a more comprehensive measure of the cost of credit, and every card issuer must disclose it.
If you carry a balance, a high APR means borrowing is much more expensive while a low APR means you’ll pay less. The APR on a credit card is typically well above the cost benefits of any credit card rewards you could earn. And it is much higher than the APR on many other kinds of debt, including most personal loans, mortgage loans, and student loans.
The high APR can cost you a lot. Say you borrowed $5,000 on a card with a 17% APR and no annual fee. If you wanted to pay off that $1,000 purchase in a year, you’d have to make payments of around $456 per month and would pay about $472 in interest over that one-year period. By comparison, a $5,000 at 6% APR would cost you just $430 per month to pay back over a year and the total interest you’d pay would be about $164.
Because the APR on a credit card is so high, you should always try to pay off your balance in full each month. But if you must carry a balance, you should look for a card that offers a special 0% promotional APR. These types of cards charge you no interest for an introductory period, such as the first 12 months you have them. If you can avoid paying borrowing costs for many months, you can pay off big purchases over time and avoid hundreds or even thousands of dollars in interest.
If you’re carrying a balance, you also need to know the APR so that you’ll know what your debt is costing you. That way you can explore any available opportunities to reduce your APR. You could potentially use a personal loan to pay off credit card debt with a high APR, for example, or could transfer current credit card debt to a balance transfer card. Balance transfer cards offer 0% promotional rates on transferred balances for a limited time. If you’re able to pay off the balance you transfer before the promotional rate expires, you could also save a ton of money using this approach.
B is for benefits and rewards
In the credit card ABCs, B stands for benefits and rewards.
Many (but not all) credit cards offer rewards for spending. These rewards may be points you can turn into airline miles you use for travel, or points you can use to buy merchandise or stay at a hotel for free. Some credit cards also offer rewards in the form of cash back, which means you get back a percentage of what you spend. You can redeem your cash back for a statement credit or have it deposited into your bank account.
Looking for a card that offers generous rewards makes a lot of sense because you will get something back for the spending you do. You could potentially earn free trips or get back as much as 5% of what you spend on certain categories of purchases.
Cards also offer other benefits, although those perks can vary dramatically from one card to another. You may be able to gain access to airline lounges, get purchase protection in case items you buy break, get free rental car or travel insurance through your card, or enjoy a whole host of other benefits.
You should focus first on APR if you ever plan to carry a balance, because getting a lower APR is more important than maximizing rewards. That’s because the card APR will always cost you more than you can get back through spending rewards. However, if you’re not carrying a balance, focus on getting the card with the most generous rewards for the kind of spending you do most often.
C is for cardholder terms
Finally, C stands for cardholder terms. Cardholder terms are the terms and conditions you agree to abide by when you become a cardholder. They are essentially your contract with your credit card issuer.
Cardholder terms can include things like the annual fee for your credit card, the late fee you may be charged, the credit line extended to you, and any over-the-limit fees you may have to pay if you max out your card. Cardholder terms also include specific details about different APRs, such as the APR you’ll pay on cash advances, balance transfers, or purchases.
Cardholder terms are usually in the fine print, but you need to read them very carefully. You need to know, for example, that you’ll usually be charged a much higher APR on cash advances than you will on purchases or balance transfers. Your cardholder terms will also let you know if there is a fee to transfer a balance. This fee could make one balance transfer card more expensive than another, even if both offer a 0% promotional APR.
One key cardholder term to pay attention to is the annual fee, or the amount you pay for your card. You will need to know whether or not you’ll have to pay a fee just for becoming a card member. Sometimes these fees can be worth it, but if you’re going to be charged one, be sure to find out how much it is and ensure that your cardholder rewards and perks justify paying it.
Finally, you should find out if rewards expire, or whether there are other circumstances that could lose you access to your rewards. This is important when evaluating whether a rewards card is a good one for you to use.
Now you know the ABCs of credit
Whenever you consider signing up for a credit card, you’ll know to always look at the APR first if you’re going to carry a balance -- and to read cardholder terms carefully to fully understand the cost of the card. Rewards and benefits are also important, especially if you’ll be paying off your card in full and want to focus on getting the most bang for your buck when you use it.
Our #1 cash back pick has a surprise bonus
This may be the perfect cash back card! That's because it packs in $1,148 of value. Cardholders can earn up to 5% cash back, double rewards in the first year, and avoid interest well into 2020. With such a deep bench of perks you'll wonder how this card packs in a $0 annual fee. Best yet, you can apply and get a decision in two minutes. Learn more with our in-depth review.
The Motley Fool owns and recommends MasterCard and Visa, and recommends American Express. We’re firm believers in the Golden Rule. If we wouldn’t recommend an offer to a close family member, we wouldn’t recommend it on The Ascent either. Our number one goal is helping people find the best offers to improve their finances. That is why editorial opinions are ours alone and have not been previously reviewed, approved, or endorsed by included advertisers. Editorial content from The Ascent is separate from The Motley Fool editorial content and is created by a different analyst team.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.