When shopping for a credit card, consumers sometimes look at the wrong metrics to compare different cards. We get pursuaded by a catchy commercial, a cool design or other less important factors. We can end up paying much higher interest penalties over the life of the card. If you carry a balance on your account from one month to the next, the most important factor in deciding on a credit card is the ongoing interest rate or APR on that card. Here is why the interest rate outweighs all other factors you may consider if you carry a balance.
A majority of credit cards have rewards programs, and these programs are heavily promoted with television ads and direct mail pieces. Whether it is a Chase's 5% cash back offer or a Capital One mileage ad, nearly every card issuer tries to convince consumers that their rewards program is the most important metric when comparing credit cards.
But that is simply not the case for those that carry a balance on their account. Most rewards programs pay one percent back on all purchases, whether it be in the form of cash back, mileage or points. Some issuers lure consumers with heavier payouts for certain categories, sometimes during specific times of the year. But no matter the payout, the interest penalties you will pay by carrying a balance will be far more costly than any rewards you may earn.
Here is an example that underscores this. Let's say you charge $10,000 on a credit card in a year where you earn 2% rewards. That means you will earn 20,000 reward points, which will typically translate to $200 in rewards. But if your interest rate is 10% on that card and you pay only the minimum payment each month for the life of that loan, you will rack up nearly $2,000 in interest charges! You can clearly see in this scenario why the interest rate is more important than the rewards you earn. Unless you are paying your card in full each month, the interest rate of your card is much more important than the rewards program could ever be.
Optimally, it is best to select a credit card with no annual fee and a majority of cards on the market come without this fee. But the interest rate is much more important than the cost of the annual fee. In some cases, paying a low annual fee may be more beneficial than getting a free card with a higher APR.
Let's say you are comparing two cards: one with a $100 annual fee and a 10% interest rate, and the second with no annual fee and a 13% interest. If you were to charge $10,000 on both those cards and just pay the minimum amount each month, you'll end up paying $2,800 in interest on the card with no annual fee and 13% interest, but only $2,000 in interest on the first card with the annual fee. In some cases, paying an annual fee could make financial sense since you could save money on interest penalties.
Many consumers look to transfer their current balance to a new card with an attractive promotional rate. In some cases, this introductory rate can be 0% interest for an extended period of time. But if you are not going to be able to pay off this entire balance in this promotional period, it is critical to look at the ongoing APR once the promotional period ends. If this is significantly higher than the rate on your existing card, it may not make sense. You have to do the mathematical calculation to determine how much you will save during this promotional period and compare that to the higher penalties you will incur with this higher APR.
In addition, consumers need to see if this 0% APR is applicable on new purchases made during the introductory period. Some cards extend the 0% to the purchases you make during this time period; others do not. Card shoppers need to be aware of this before applying for a specific balance transfer offer.
In these three scenarios, the interest rate is the most important metric in shopping for a credit card if you carry a balance from one month to the next. While other features might be more tempting, the interest rate is going to be the critical factor when you shop for a credit card.