Choosing a Credit Card: Rewards, APR and Hidden Fees

Getting this backwards is expensive. A card paying 2 percent cashback at 24 percent APR loses money for anyone carrying a balance, because the interest dwarfs the rewards by an order of magnitude.

Rewards arithmetic for transactors

Flat-rate cashback cards pay 1.5 to 2 percent on everything and require no thought. Category cards pay 3 to 5 percent in specific areas — groceries, dining, fuel — often with quarterly caps and sometimes with activation requirements.

Work out your actual spending by category before choosing. A card paying 4 percent on dining is worth little to a household that rarely eats out, and a 2 percent flat card frequently beats a category card once you account for the categories where the bonus does not apply.

Points and miles are harder to value because redemption rates vary. A reasonable approach is to value them conservatively at around one cent each unless you have a specific redemption you know you will use. Transferable points to airline and hotel partners can be worth considerably more, but only for people who will do the work.

Annual fees can be worth paying, conditionally

A $95 annual fee needs $95 of additional value over a no-fee alternative before it breaks even. On a card paying 1 percent more than your free option, that requires $9,500 of annual spending in the qualifying categories.

Premium cards with $400 to $700 fees offer credits — travel, dining, streaming — that make the arithmetic work only if you would have spent that money anyway. Credits you have to remember to use, in categories you do not naturally spend in, are marketing rather than value. Count only the credits you are certain to use.

Sign-up bonuses and the spending requirement

Welcome offers are genuinely the largest single value available, often worth several hundred dollars. The requirement is spending a set amount within three months.

The trap is manufacturing that spending. If hitting the threshold means buying things you did not need, the bonus cost you more than it paid. Time applications to periods when you have a large planned expense — an insurance premium, a tax bill, a holiday — rather than creating one.

The fees people do not notice

Foreign transaction fees run around 3 percent and appear on a surprising number of mainstream cards. If you travel or buy from overseas retailers, this alone should decide your choice.

Balance transfer fees are 3 to 5 percent. Cash advance fees are typically 5 percent with no grace period and a higher APR that accrues from day one — cash advances are close to the worst borrowing available and should be treated as an emergency-only facility.

Late fees are capped by regulation but the real cost is the potential penalty APR and the credit report entry once a payment is 30 days late. Automate at least the minimum payment to remove this risk entirely.

Understanding the grace period

Cards offer an interest-free grace period on purchases only if the previous statement was paid in full. Carry a balance and you generally lose the grace period, so new purchases begin accruing interest immediately.

This is why partial payment is worse than it appears. Paying most but not all of a statement does not simply leave the remainder accruing — it can expose the following month's spending to interest from day one.

Choosing well

Decide honestly whether you are a transactor or a revolver, based on the last twelve months rather than intention. Revolvers should look for the lowest APR available, or a credit union card, and ignore rewards entirely.