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Shopping for the Right Credit Card |
Smart consumers comparison shop for
credit, whether they're looking for a mortgage, an auto loan, or a credit card.
Comparison shopping is important because it could save you money.
When you're looking for a credit card, be sure to consider the costs and
terms. They can make a difference in how much you pay for the privilege of
borrowing. Compare them with the costs and terms of the cards you already have
to find the plan that best fits your spending and repayment habits.
Key costs and terms to consider are the annual percentage rate
(APR) for goods and services as well as for cash advances, the
annual fee, and the grace period. Also
compare cash-advance fees, late-payment charges, and over-the-limit fees.
Besides looking at these costs and terms, think about your typical
bill-paying behavior. Do you pay your outstanding balance in full each month? Or
do you usually carry over a balance? Matching the credit card plan to your needs
could save money.
Credit Card Interest Rates
Credit card issuers offer variable-rate, fixed-rate, and tiered-rate plans.
For variable-rate credit card plans, the interest rate
is calculated according to a formula. Three of the most commonly used formulas
are
- Index + Margin = Variable rate
- Index x Multiple = Variable rate
- Index + Margin x Multiple = Variable rate
The most common indexes used by credit card issuers are the prime rate;
the one-, three- and six-month
Treasury bill rates; the federal funds rate; and the
Federal Reserve discount
rate. Most of the indexes are published in the money or business section of
major newspapers. If the index rate used for your credit card changes, the rate
on your card will, too.
The margin is a number of percentage points chosen by the credit card issuer.
The card issuer also chooses the multiple.
The interest rate on a fixed-rate credit card plan, though not explicitly
tied to changes in another interest rate, also can change over time. The card
issuer must notify you before the "fixed" interest rate is changed.
A tiered interest rate means that different rates apply to different levels
of the outstanding balance (for example, 16% on balances of $1 - $500; 17% on
balances above $500).
Some card issuers may have a policy that raises your interest rate if you
make late payments. For example, if you make 2 late payments within 6 months,
the card issuer may raise your interest rate from 18% APR to 24% APR. If such a
penalty rate applies to your card, the issuer must
include a notice in the solicitation materials.
Card issuers may also charge different rates for different types of
transactions. For example, the card may carry one rate for purchases of goods
and services, another rate for cash advances, and still another rate for balance
transfers.
How Much Will You Pay?
The finance charge -- that is, the dollar amount you
will pay to use credit -- depends on your outstanding balance and the periodic rate
in your credit card plan:
- Finance charge = Outstanding balance x Periodic rate
What Is the Outstanding Balance?
The outstanding balance can be
calculated in several ways, and the method of calculation can make a big
difference in the finance charge you will pay:
- Average daily balance method including new purchases. The balance is
the sum of the outstanding balances for every day in the billing cycle
(including new purchases and deducting payments and credits) divided by the
number of days in the billing cycle.
- Average daily balance method excluding new purchases. The balance is
the sum of the outstanding balances for every day in the billing cycle
(excluding new purchases and deducting payments and credits) divided by the
number of days in the billing cycle.
- Two-cycle average daily balance method including new purchases. The
balance is the sum of the average daily balances for two consecutive billing
cycles. One daily balance, that for the current billing cycle, is calculated by
summing the outstanding balances for every day in the billing cycle (including
new purchases and deducting payments and credits) and dividing that total by the
number of days in the billing cycle. The other daily balance is that from the
preceding billing cycle.
- Two-cycle average daily balance method excluding new purchases. The
balance is the sum of the average daily balances for two consecutive billing
cycles. One daily balance, that for the current billing cycle, is calculated by
summing the outstanding balances for every day in the billing cycle (excluding
new purchases and deducting payments and credits) and dividing that total by the
number of days in the billing cycle. The other daily balance is that from the
preceding billing cycle.
- Adjusted balance method. The balance is the outstanding balance at
the beginning of the billing cycle minus payments and credits made during the
billing cycle.
- Previous balance method. The balance is the outstanding balance at
the beginning of the billing cycle.
Depending on the balance you carry
and the timing of your purchases and payments, the average daily balance method
excluding new purchases, the adjusted balance method, and the previous balance
method tend to result in lower finance charges than the other
balance-calculation methods.
What Is the Periodic Rate?
The periodic rate is the rate you are
charged each billing period. Usually the periodic rate is the monthly interest
rate, calculated by dividing the card's APR by 12. If your card has different
rates for different types of transactions, then different periodic rates will
apply to those balances. For example, if your card has a 12% APR on purchases,
the periodic rate for purchases is 1%; and if your card has a 24% APR on cash
advances, the periodic rate for cash advances is 2%.
The Right Card for You
While the outstanding balance and the periodic rate are important factors in
choosing a credit card, they shouldn't be your only considerations. Other plan
features may be more important to you, depending on how you use the card. For
example, if you don't always pay your monthly bill in full, you'll probably be
more interested in a card that carries a lower APR. On the other hand, if you
always pay your monthly bill in full and card enhancements such as frequent
flyer miles don't interest you, your best choice may be a card that has no
annual fee and offers a longer grace period.
The grace period is the number of days between the statement date and the due
date during which you can pay your bill without incurring a finance charge. The
card issuer may refer to the beginning or ending point of the grace period and
tell you about any conditions that apply. For example, the issuer may say you
have "25 days from the statement date, provided you have paid your previous
balance in full by the due date." Keep in mind that the statement date is
not the date on which you receive the bill; it is the date on which the
issuer prepares the statement, which may be a week or two before you actually
receive the bill in the mail.
How Much Could You Save?
The following example illustrates the annual savings you could achieve by
switching to a credit card plan with a lower APR and no annual fee. The average
monthly balance used in this simplified example is around the national average
for consumers with credit card debt.
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