Types of Credit Cards
I confess, I love using credit cards. I charged over $45,000 on credit cards last year. I love the convenience of using them to book air travel and to make online purchases. I love the fact that I never have to carry much cash or visit banks or ATMs. I bet I spent less than $500 in cash last year. I also like the consumer protections afforded by credit cards, and I have actually used the rental car insurance benefits on a card. I’ve taken advantage of idiotic credit card offers, such as 0% for 15 months or even one deal I had that was 1.9% indefinitely when money market funds and savings accounts were yielding 5%. I like being able to spend/save the float I get from paying for most of what I buy 30-45 days after I pay for it. Of course, I’m very aware that I probably spend more using credit cards. Some studies suggest I may be spending as much as 15% more.
There are really four types of credit cards. The first is a rewards card. This is for someone like me who prefers to use credit cards instead of cash, checks, or debit cards, and puts a lot of money on them each month. The rewards may be gift cards, airline miles, rewards points, or cold hard cash. There is sometimes an annual fee, and the interest rate is usually pretty high, but since no balance is carried, the use of the card is usually a net positive to the user (aside from the behavioral aspect mentioned above.) The going rate for these is about 1%, i.e. the card pays you 1% of what you spent. Since they’re sticking the merchants with 2-4% fees on each transaction, it’s easy to pay you 1%. They also often pay more for certain categories such as gas, supermarkets, restaurants, air travel, or even shopping at their particular store. Sometimes these categories are fixed and sometimes they rotate.
The second type of credit card is the promotional offer card. These are similar to rewards cards, but they offer a big reward for the first use or once you put a small amount of money, such as $300, or $1000 on the card. For example, I saw one in the mail they other day that gave you the equivalent of a round trip plane ticket for charging $1000 in the first 3 months you have the card. Usually the credit card companies offer these cards to get you to use a card that really isn’t that good in the long run. High interest rates, annual fees, and low ongoing reward are the norm. Obviously, if you just use the card for the promotion, you can come out pretty far ahead, but it does involve some hassle to open and cancel the account, and might not be worth your time.
The third type of credit card is the 0% transfer offer card. Most cards will give you a period of time at 0%, from 6 months to 15 months, and sometimes they don’t even charge you a fee to do it. These are useful if you are trying to work some arbitrage scheme, such as charging things on the card, paying the minimum, and then investing the money you would have used to pay it off in a high-yield bank account or a CD. When the 0% term is up, you pay off the card. These cards can also be useful when you are trying to get out of debt. While I agree with Dave Ramsey that you can’t borrow your way out of debt (it’s a behavioral issue, not a mathematical one), it just doesn’t make sense to be making payments on multiple credit cards charging you 29% interest when you could be making the same payments on one card charging you 0%. The important thing, of course, is to make those same payments, and not just run up the balances of the other cards again. Unless something has changed drastically in your financial mindset, if you’ve run up significant credit card balances in the past, you probably shouldn’t be using a credit card at all.
The last type of credit card is the long-term low-interest rate card. These are often available from your local bank or credit union. Perhaps it charges you 7-9% without any fees. If for some reason you actually have to use a card for credit from time to time, it’s best to get one with a low interest rate and no annual fee. These rates are higher than better loans, such as home equity loans or business lines of credit, but it is also much more convenient to use the card, and in the short-term (a few months) the cash flow benefits may outweigh the interest rate costs.