Types of credit cards When used wisely, a credit card is a great tool for consumers.  It is important for every consumer to understand what ...

Types of credit cards

When used wisely, a credit card is a great tool for consumers. It is important for every consumer to understand what a credit card is and what types of credit cards are available to them.

Credit cards (easy explanation)

What is a credit card?

Starting at the beginning, a credit card is a small plastic or metal card issued by a bank or institution. It is a tool that allows consumers to obtain loans to make payments. At the end of a month, the consumer must pay the loan in full or pay interest on late payments. The benefit of credit cards is that they typically offer rewards (ie 1% cash back) to consumers who use their cards.

How does a credit card work?

In a nutshell, a credit card allows you to make purchases over a period of time (usually a month) without paying anything until the end of the time period. The simple steps to obtain and use a credit card are as follows:

• Application: You must apply for a credit card. The higher your credit score, the more likely you are to get a good credit card.
• Usage: Once you have a credit card, you can use it to make purchases for a month or period of time. You will not owe any money for any purchases you make until the end of the time period.
• Payment: At the end of the time period, you will receive a statement with the amount you owe based on your purchases. It is best to pay off the credit card in full each month. So if you spent $100 on your last monthly statement, you'll pay $100 in total. If you don't pay your balance in full, you may be subject to additional interest charges.
• Rewards: One of the biggest benefits of credit cards is that they offer rewards to users. For example, many cards offer 1.5% cash back on all purchases, which basically means everything will be at a 1.5% off sale for the rest of your life.

One of the easiest ways to understand credit cards is to compare them to debit cards. With debit cards, you pay instantly (with money from a checking account) when you make a purchase. With credit cards, you delay having to pay until the end of a period of time.

Advantages and disadvantages of credit cards

Advantage:

• Rewards – Many credit cards offer great rewards (cash back, points, travel credits, and other offers).
• Building Credit: When used responsibly, having a credit card will help you build credit and receive better interest rates on future large purchases that require a loan (like homes and cars).
• Convenience: Carrying a small card instead of cash and coins is more convenient and safer. If you lose your card, you can usually cancel it quickly to avoid losing money to a potential thief.
• Time Value of Money: A smaller benefit, but the money in your pocket now is worth more in the future. Being able to delay payment until the end of the month allows you to earn more with your money, whether through investments or high-interest savings accounts.

Cons:

• Interest: If you fall behind on your credit card payment, you will likely pay interest on top of what you owe. This is a big risk and a big reason to always pay on time and in full (when possible). Interest has the ability to add up quickly, erode credit card rewards, and put people in debt.
• Frivolous spending: While delaying payment can sometimes feel like you're not paying at all, it's important to remember not to make any purchases you can't afford. If you have a budget, stick to it. If you need a justification as to why re-read the “interest” bullet point above.

Annual Fee vs No Annual Fee

The first question when diving into credit card types is whether you want to select a card with an annual fee or no annuity. An annual fee is a one-time payment you make each year (ie $100) to use your credit card. In return, you typically get better rewards (ie 2% cash back instead of 1% cash back).

The answer to this question is usually quite simple, but it does require some math. In general, low spenders (or someone who doesn't travel) shouldn't use annuity cards, while high spenders (or frequent flyers) may benefit from annual fee cards (if they spend a lot in the niche of the card). See the brief example below comparing two Chase credit cards:

Card details:

• Pursue unlimited freedom
  • $0 annual fee
  • 1.5% cash-back
• Chase Sapphire Reserve Card (niche = travel/dining)
  • $550 annual fee (but only a $250 fee when using a $300 travel credit)
  • 3% reimbursement on travel expenses (assumed below: 30% spent on travel and meals)
  • 1% back on everything else
  • Earn 50% more when you use points to travel (assumption below: all rewards are redeemed for travel)

Person A: Low Spending, $500/Month

• ChaseFreedomUnlimited: earn $90 a year
• Chase Sapphire Reserve Card: Earn $144 per year (assumes: spend 30% on travel/dining and redeem all travel rewards), but at a net cost of $250- $106 per year.

Person B: High Spending, $3,000 / Month

• ChaseFreedomUnlimited: earn $540 a year
• Chase Sapphire Reserve Card: Earn $864 a year (assumes: spend 30% on travel/dining and redeem all travel rewards), and at a cost of $250, the net is $614.

As you can see, the person who spends a lot (Person B) benefits from the card with an annual fee (Sapphire Reserve) while the person who spends less (Person A) benefits more from a card with no annual fee (Freedom Unlimited).

Types of rewards credit cards

There are different types of rewards that credit cards offer, from simple cash back to various point systems. In general, the type of reward a card offers don't matter as much as the monetary value of that reward. As long as you spend money in that category every year, you'll benefit from rewards (if you don't stay in hotels when you travel, don't get a hotel rewards card).

• Cash Back: Rewards with cashback to your account to pay your next bill, deposit to your bank account, or sometimes purchase through different outlets on the credit card website. Example: Chase Freedom Unlimited.
• General Travel/Points: Point rewards that can be used to book travel (check the card program or various sites to see how much the points are worth, but generally 1 point = $0.01). Example: Chase Sapphire Reservation.
• Airline: An airline-specific travel card that earns you points (or thousands) to book travel through the designated airline brand. It often offers extra perks like free checked baggage or lounge access. Example: United Explorer Card.
• Hotel: Travel card specific to a hotel brand that gives you points to book travel through the designated hotel chain. Example: The World of Hyatt credit card.
• Retailer: A card that gives you additional rewards when you shop at a specific retailer (rewards are usually redeemed at that same retailer). Example: TJX Rewards Card.

Cards 0% APR

Last on the list of credit card types are 0% APR and low-interest cards. In general, these cards are better for consumers with credit card debt because the interest you owe on them is lower than on typical cards. On the other hand, they usually offer little or no rewards because their benefit is to give you a discount on the debt you owe.

Again, the general advice is to avoid the situation where you need to look at 0% APR and low-interest cards, but they can be a helpful tool for consumers in a situation of high credit card debt.

Other Types of Credit Card Perks to Consider

With the above types of credit cards, we focus primarily on direct monetary benefits and costs. There are a few other factors to consider when choosing a card, including:

• Foreign transaction fees.
• Travel benefits: lounge access, free checked baggage, etc.
• Travel insurance: cancellation protection, delayed flight protection, etc.
• And much more. Be sure to diligently compare credit card details before signing up!