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Credit cards may seem like a straight forward form of
credit but if you're not careful you could be spending far more
money on interest and annual fees than you need to be. We are
going to walk you through the basics of understanding how credit
cards work in order to put you in a position where you can
ultimately pick the card that is right for you.
The first thing you must remember about financial institutions
that offer credit cards is they are in the business to
make money. They must remain viable businesses, and will always
have shareholders that demand a return on their investment.
So although we sometimes get in the mind set that they're just
trying to milk us for every cent we have, they aren't because
it's not in their long-term best interest. There are three ways
companies make money from credit cards:
- Interest - The interest charges are based on your outstanding
balance from one month to the next and they represent the
largest portion of income made from credit cards.
- Annual Fees - Some credit cards require their holders
to pay a yearly fee. In theory you will receive a lower interest
rate, or other added benefits with a credit card that requires
a fee.
- Transaction Fees - Every time you make a purchase, the store
where you make your purchase is charged a fee which is generally
a percentage of the sale (in the range of 1-3%).
Now how does this help you as a customer? Well, there are three
basic types of credit card customers and each have different
levels of profitability for the financial institution. If you
know how profitable you are for them you know how much power
you have as a customer. For example if a profitable customer
requests a $2,000 credit limit increase, you will be far more
likely to receive that credit increase than an unprofitable
customer. The three types of customers are as follows:
- Unprofitable - These are the customers who use their credit
card to purchase far beyond their means and their future
means. Therefore, these customers have large outstanding balances
and frequently miss payments. In most cases large portions
of their credit are never repaid and cause a great deal of
expense to the financial institutions.
- Profitable - These customers use their credit card
to purchase within their current means. Generally, they always
payoff their monthly balances and as a result are never charged
any interest on the credit they received.
- Very Profitable - These are the customers who are intending
on making more money in the near future. For example, a student
nearing graduation may decided to put his/her graduation trip
on their credit card. The balance may carry forward
on the credit card for 3 or 4 months until their job
starts and they are able to pay it back.
Now, based on which type of credit card customer you
are, we can determine what credit cards are right for you. Simply
read the paragraph that applies to your type of customer.
So you've determined that you're the type of person who usually
carries a balance but pays it off every few months. The credit
cards which best suit you are ones that have very low interest
rates as you typically carry a balance over from the previous
month. Therefore, your largest expense in having a credit card
is the monthly interest charges. It is usually worth while to
look at the credit cards which require an annual fee because
they generally offer a considerably lower interest rate. If
the lower interest rate saves you enough to cover the annual
fee then you should sign-up.
So you usually pay off everything you purchase from month to
month. The credit cards which best suit you are the ones
that do not require an annual fee. It also doesn't matter to
you about the interest rate as you pay off your monthly balances.
If you feel in the future you may be carrying a balance the
interest rate should be taking into consideration. You can typically
find credit cards that offer greater rewards and benefits that
have higher interest rates which will not affect you as long
as you continue to pay off your balance.
So you're having a little trouble meeting your monthly payments
and the interest seems to be adding up faster than you can pay
it down. Well, there is one of two options in this case. You
can look to credit card companies that offer lower interest
rates for the first few months (typically 6) on your balance
transfer. This usually results in a significant savings on interest
and allows you to slowly pay down your balance and overcoming
your unmanageable debt. The other option is to consolidate your
debt. For more information about debt consolidation see our
debt
consolidation help page.
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