Financial institutions earn plenty of profit from their credit card businesses. Therefore, it’s no surprise that they flood your mail and email with offers to apply for their cards, usually at low teaser or introductory rates. However, there are realities you have to understand before you decide to get your first credit card or add to the credit cards which you already have. Here are things you should know before applying for a credit card.
Credit Cards = Loans
Essentially, credit card companies are in the business of “loaning” funds. The loan could take the form of the payment they float for the purchases you make (cash advances) and balances from other cards transferred to that card. The companies make their money from that in a number of ways. Those include, but not limited to: Upfront fees charging interest when the balance on the credit card is not paid within the stated grace period if there is one, transaction fees, penalties for late payments and fees for special services such as warranties.
Given all the money involved, the financial institutions evaluate risk comprehensively. The standard tool they use is what is known as a FICO score (short for Fair, Isaac and Company, which invented the system). The results of that analysis determine if those applying for a credit card will get one if the card is not pre-approved, at what interest rate and the credit limit. The FICO score takes into account bill payment history, including on credit cards, employment status and income, debts and record of lawsuits, arrests or filings for bankruptcy. Three national credit bureaus track that information: Equifax, Experian and TransUnion. Their reports often differ from each other and these credit scores range from 300 to 850. A good score is about 750.
A FICO score is a highly sensitive entity impacted by everything you do which gets on the radar of the three rating bureaus. For example, even if you apply to check your FICO score for free, your score could drop down several points. That’s because in the world according to FICO, inquiries about credit status are viewed with suspicion. Yet, there’s a catch-22 here since it’s useful to review credit reports periodically to identify inaccurate or outdated information. But to avoid being penalized for too many “pulls” on your credit report, you have to do your homework to decide which card to apply for versus applying for several. Those multiple “pulls” on your credit history will most likely bring down your score.
Business Or Personal Card
The first decision before applying for a credit card is to determine if you want a business or a personal card. Business cards provide features like itemized expenses, cards for employees, higher credit limits and ease in getting loans. For many businesses, they are a must-have tool. Startups frequently use them for funding they can’t get from banks.
Factors To Consider
The next factor to consider, for both business and personal cards, is how you want to use it. This will determine what kinds of cards to evaluate, what terms and conditions matter to you and then which particular card to select. The Federal Credit CARD Act of 2009 mandated that detailed information be available in order to compare cards. There are many sites online that can help you compare card features and rates, such as CardRatings.com. It’s always best to visit more than one credit card site or bank to help collect the best information to compare different cards.
At this point in the decision-making process, the key variables to look at include:
- Upfront fees. This includes fees such as card memberships and annual maintenance.
- Teaser or introductory rates. How long do they apply? The lower and longer the terms of the rates, the better.
- Regular interest rates or APR. This could depend on your FICO score and/or financial market conditions.
- Variable rate. Some companies state the right to raise interest rates at any time.
- Grace time. The period in which balance can be paid off without interest charged.
- Charges. How finance charges are calculated for the balance.
- Penalties. The penalty fees and boosts in interest rates for late payments.
- Balance Transfer. Transaction charge, teaser rate, and length it applies for balance transfer. Then, the regular APR.
- Cash Advances. Transaction charge, teaser, then regular interest rates for cash advances, as well as other terms and conditions, such as no grace period.
- Extras. Fees charged for services such as making online payments and warranties.
Usage Scenarios For Different People
Here are some basic scenarios to help you make a decision on which card is best for you and what features to review. See if you fall into one of these scenarios.
- For you, the card is a convenience and means of record-keeping, so you will pay off balances during the grace period. Therefore, be sure look at the upfront fees, not interest rates when first looking at different cards.
- You plan to use the card to purchase big-ticket items. Therefore, interest rates matter a lot. It is most cost effective to charge those rather than take a cash advance which has higher interest rates and often more stringent terms and conditions, such as no grace period.
- You anticipate balance transfer offers to remain plentiful so you focus on the introductory rate and length, not the later regular APR. When the teaser ends, you plan do another balance transfer to another card you already have.
The next step when looking for a credit card is to check to see which have a rewards program. For some cards providing rewards, the interest rate could be higher. Be sure to read all the fine print before jumping for any incentives. If you find cards which don’t trade off benefits for higher APRs, then the card you choose would be aligned with what incentives fit your lifestyle. For non-travelers, cash-back rewards might be the best. For travelers, the focus is on what relates to miles and lodging. For deal lovers, department stores frequently offers discounts on select purchases.
Special Use Cards
Special use cards are specific cards that help you work towards a goal. For example, you may want get an affinity card to have a charity or your Alma mater benefit from your purchases. If you’re a college student who wants the convenience of a card and the ability to build a credit history, you may want to pursue a special, low-limit credit card. If you have a bad credit score and want to rebuild your credit, one possibility is to apply for a card which requires collateral. This could be jewelry, stocks or a car.
Choosing the correct credit card for your needs is important for your financial well-being. Remember, the more credit financial institutions extend you; the more probable it is they will make money, probably a lot of it, from you. Also, if the offers in the mail are lower than your current interest rates, thanks to the CARD Act, you can contact the financial institutions you are already doing business with for better deals.