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If you've decided to get a new credit card, or are thinking about canceling one of your existing cards and need to decide which one, it's important to make an informed decision. Credit card issuers tend to handle fees and interest in different ways, and sometimes an issuer will even use different rules for the different cards in its lineup. Before you make a decision about any credit card, pull out a copy of its disclosures, get out your magnifying glass, and look for the following danger zones.
1. Teaser rates
When you compare two or more credit cards, the first thing you look at is probably the cards' interest rates. Credit card issuers know this, so to attract new borrowers, they will sometimes offer a "teaser" rate. This low introductory rate will balloon upward into a much higher APR within a few months, and any balance on that card at that point will be charged the new, higher interest rate. Worse, if you're even one day late on payments during the introductory period, the interest rate may change to a higher rate immediately.
2. Balance computation methods
Most credit card companies use one of three basic methods to calculate your monthly finance charge: the adjusted balance method, the average daily balance method, or the previous balance method.
The adjusted balance method takes your balance at the end of the previous billing cycle, subtracts any payments you made during the current billing cycle, and uses the result to determine your finance charge. The average daily balance method looks at the beginning balance for each and every day in the billing cycle and subtracts any payments made to your account on that day. These daily balances are then added up and divided by the number of days in the billing cycle to find an "average daily balance." In the previous balance method, finance charges are based on your balance at the beginning of the billing cycle (in other words, your previous balance).Credit cards also used to use a fourth method known as the two-cycle balance, which could end up charging interest twice on the same debt -- but fortunately, that computation method was outlawed by the CARD Act.
The adjusted balance method typically yields the lowest finance charge and is therefore the most favorable method for borrowers. The average daily balance method typically yields the highest finance charge, with the previous balance method falling somewhere in between the two. Not surprisingly, most credit card issuers use the average daily balance method to calculate finance charges.
3. Multiple interest rates
Once upon a time, credit cards each had a single interest rate for all kinds of purchases and other activities. Nowadays, it's common for a credit card to have multiple interest rates: one for purchases, one for balance transfers, one for cash advances, a punitive one if you're so much as a day late making a payment, and so on. It's important to take all of these rates into consideration when choosing a card, not just the familiar "purchase" rate.
4. Fixed versus variable rates
Most credit cards charge a variable interest rate pegged to an index of some sort (typically the prime rate). These rates are expressed in the form "Prime + 15%," for example. Depending on how stable the prime rate is at the moment, the rate on variable interest rate cards can bounce up and down from month to month, sometimes dramatically.
A few cards offer borrowers a fixed rate of interest instead, which can be reassuringly stable -- especially if the prime rate is rising fast. However, read the fine print carefully regarding that fixed rate: It may only apply for a limited period of time, or the credit card issuer may replace it with a much higher variable rate should you fall behind on payments or go over your card limit.
5. Fees, fees, and more fees
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Along with a plethora of interest rates, credit cards typically come with a plethora of fees. There are annual fees, transaction fees, late fees, over limit fees, balance transfer fees, and so on, ad nauseum. Review the fee schedule to determine how much different fees will cost you as well as what will trigger them; this can make a significant difference in how good of a deal a card really is. When considering a new credit card, it's particularly important to search the fine print for any mention of an annual fee. For example, some credit card offers will boast "No Annual Fee!*" in huge letters, and buried in the footnotes, in tiny little letters, you'll find the text "*...for the first year."
6. Grace periods
Most borrowers assume that if they pay off their balance during the current statement cycle, they won't be charged interest. That's only true if your credit card gives you a grace period, which isn't always the case. Some cards have no grace period at all; others only give you a grace period if you pay off your balance in full every month. If your card does have a grace period, the CARD Act requires the issuer to send you your bill at least 21 days before the grace period ends so you have a chance to pay off the balance before interest charges apply.
7. 0% promotional rates
Some credit cards, especially store cards, will offer you a 0% interest rate for a certain period of time. Sounds like a great deal, right? It can be -- but only if you pay off the balance in full before the promotional period expires. If you have any balance at all on the card when the promotion runs out, the card issuer can charge you for your entire balance, retroactively, at the card's normal rate of interest. So, if you buy a $2,000 computer during your promotional period, and you pay off all but $10 of that balance before the promotion runs out, you may still get charged interest on the full $2,000.
Where you can find all of this information
Thanks to the CARD Act, credit card issuers are required to disclose information on interest rates, fees, and more. Unfortunately, these disclosures are written in a way that makes them almost impossible for someone without a law degree to read.
The CARD Act also requires card issuers to post these disclosures on their websites, so you can cheat a little by pulling up the disclosure and searching for important terms (such as "grace period"), and then reading the relevant paragraph in detail. Most web browsers will open a search box for you if you type the CTRL and F keys; just type the term you're searching for into that box and hit enter.
If you get an offer in the mail, look for a separate disclosure that hits the highlights on fees and other critical information; this may give you enough information to decide whether or not to apply for the card. And if you just can't find the information you need, move on to another card. You'll save a lot of money in the long term.
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