How to Better Understand Your Credit Card—and Figure Out Which One Is Right for You

Understand how interest accumulates—and the difference between deferred and accrued interest.

Most credit cards have either accrued interest or deferred interest. Accrued interest adds up regularly. If you carry a balance on a credit card with accrued interest, interest will be calculated based on your annual percentage rate (APR) and added to your total balance at the same rate every month, no gimmicks or surprises.

Deferred interest, on the other hand, typically offers an introductory interest rate and then adds on interest later if the complete balance is not paid off.

"Deferred interest really pertains to things like store cards," says Mike Kinane, a retired banking executive, who previously was the head of U.S. Bankcards at TD Bank. "If you carry a balance for the promotional period and go past that promotional period with the balance, interest has been deferred since day one. You'll end up paying interest for [everything that has accumulated] since you made the purchase."

Most people will encounter deferred interest when they're signing up for a store credit card that offers, for example, zero percent interest for up to six months. If you can't afford a large purchase (like furniture) all at once, this promotional store card will let you space out payments over six months without paying anything extra in interest.

If you do not pay off the complete balance within the introductory period or you miss a payment, though, you may see all the interest that would have accumulated over the period appear on the card.

With deferred interest, a zero percent introductory APR doesn't actually eliminate interest; it pushes it off for the prescribed period of time, so you may have to pay it back later. If this happens, "you're really still paying all that interest," says Andrea Koryn Williams, CFP, CLU, ChFC, a wealth management advisor with Northwestern Mutual. "It's something you definitely want to pay attention to," she says.

Cards with deferred interest can still work in your favor, but only if you are able to pay off the complete balance within the introductory period. Williams suggests breaking your balance up into manageable chunks that you can pay off before the promotional period ends; be sure you understand when that is—and if the store card has deferred interest—before you sign up.

Kinane says most general-purpose cards will have accrued interest, not deferred, so you can rest a little easier.

Know your interest rate.

The interest rate or APR of your credit card is one of the most important numbers you should know. Still, "most consumers don't have a really good understanding of what their interest rate is," Kinane says.

Part of this confusion may stem from the fact that many cards have more than one interest rate. Types of interest rates on credit cards include a contract or standard rate, a penalty rate, a cash advance rate, and a promotional rate; to find out which your card has, read your credit card contract. (Yes, even all the fine print.)

Your contract or standard rate is the rate in effect in normal circumstances, when your account is in good standing and you've made on-time payments that are at least the minimum balance.

If you miss a payment or pay less than the minimum balance, a penalty rate may be imposed: These are typically higher than your contract rate.

Cash advances—when you use your credit card to borrow cash at a bank or ATM—may also have a separate interest rate.

Promotional rates—such as zero percent interest for a determined period of time—will default to your contract rate after the promotional period ends. Balance transfer introductory rates, in which you pay no interest on a balance transfer for a period of time, function the same way.

Remember that the APR is the annual rate, and that credit card interest is calculated on a daily basis. To calculate your daily interest rate, divide your APR by 365. If you pay off your credit card balance in full every month, you won't have to pay interest.

It's also important to remember that your APR, even your contract rate, can change. Rates can go up and down depending on your credit history, market conditions, and other factors. Your credit card issuer is required to notify you of any changes, though, so you won't be caught off guard—and in some cases, you may even be able to opt out of the rate change.

Be aware of what a "good" APR means.

In almost all cases, a lower APR on a credit card is better. This means interest—and thus your total debt—will accumulate more slowly. Credit card rates tend to be much higher than the rates on other types of debt, which is part of why credit card debt is so difficult to eliminate.

According to WalletHub, the average credit card interest rate is 20.75 percent for new offers and 16.27 percent for existing accounts. For comparison, as of July 15, 2022, the APR for a 30-year fixed-rate mortgage is 6.25 percent, according to NerdWallet. The average student loan interest rate is 4.99 percent.

Your APR will depend on your credit score, credit history, income, and other factors. For the most part, people with higher credit scores and good credit history will qualify for lower rates; people with low or credit will qualify for higher rates. If you're able to rein in your credit card spending, though, and always pay off your credit card statement balance in full, your interest rate is irrelevant, according to Kinane, as you'll never have a balance for interest to be charged on.

Don't forget your credit limit.

Getting a credit card doesn't mean you can buy whatever you want, whenever you want it. All cards come with a credit limit, which controls how much money you're able to spend every month. Your credit limit can be low—some cards stop people at $500 per month—while some can be impossibly high: It depends on your credit history and income.

If you spend too much money with your credit card, you'll max out your card, and you could be charged a fee or have charges declined. If you carry a balance every month, too, your actual spending limit will get smaller and smaller as your balance grows.

Even if you pay off your credit card every month, putting too much money on the card can damage your credit score, thanks to your credit utilization rate or ratio. Let's say your credit limit is $10,000 a month.

If you use your credit card to buy $5,000 worth of goods in a month, your credit utilization rate will be 50 percent, and your lender may be concerned that you're living beyond your means or that your debt-to-income ratio is too high. (Generally, a good credit utilization ratio is 30 percent.)

The best way to avoid getting dinged for putting too much money on your credit card—even if you are able to pay it off—is to ask for a credit limit increase. If you have proven that you're a reliable credit card user, your credit card company may increase your limit immediately. Keep your spending low, and your ratio will stay low, keeping your credit score and debt-to-income ratio in good shape.

Watch those extra fees.

Interest rates may be part of what makes credit card debt so high, but some credit cards carry other fees you may have to pay. Read your credit card contract carefully to make sure you understand those fees, how they're incurred, and how you can avoid them.

One of the most common fees is a late or penalty fee, which can be added to your balance if you miss a payment, have a late payment, or do not make the minimum payment.

Another common fee—one that can't be avoided—is an annual fee. Some credit cards charge annual fees on cards that offer rewards and other perks to credit card users; these cards can have lower APRs, but the annual fee is automatically added to your account every year. Fortunately, not all credit cards charge annual fees.

If your bank doesn't honor a payment you've made on your credit card bill—which might happen if there's not enough money in your account to cover the payment—you may be charged a returned payment fee.

Other common fees that can be incurred when you use your credit card for different transactions include balance transfer fees, over-limit fees, cash advance fees, expedited payment fees, foreign transaction fees, and card replacement fees. Your credit card contract will list all the fees associated with the card: Read carefully.

Know if you need a secured or unsecured credit card.

Secured debt is debt that is associated with a tangible item (aka, collateral). Mortgages are a form of secured debt, because if you do not pay your mortgage loan, the house can be taken from you. The same goes for car loans. This is how certain types of loans have lower interest rates than others: Lenders are taking on less risk because they know that, if you don't pay what you owe as agreed, they can reclaim the item you bought with your borrow money.

Unsecured debt is much riskier for lenders because they have nothing to reclaim if you do not pay what you owe. Credit cards are a form of unsecured debt because they're not associated with any one item lenders can reclaim as payment, and thus have higher interest rates. Lenders rely on credit scores and credit history to determine if they're going to offer a credit card to someone, so if you have a low credit score or spotty credit history, qualifying for a credit card with favorable terms (or qualifying at all) can be difficult.

Fortunately, there's a way for people with low credit scores or no credit to qualify for credit cards: secured credit cards.

With a secured credit card, Kinane says, borrowers will offer up a little bit of money—$500, say—to serve as collateral on their card. They will get a credit card with the understanding that, if they don't make their payments, they will lose the money they have given the credit card company.

Secured credit cards make credit card lending a secured loan and are great for people who need to improve their credit or who have no credit, such as college grads, Kinane says.

If you're able to qualify for an unsecured credit card with favorable terms, that's likely the best option for you. If you can't, though, an unsecured card is a great option for building credit.

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Get familiar with (and take advantage of) rewards.

Credit card rewards are all over the place. Travel credit cards offer points and miles for travel and airlines, flight vouchers, checked-bag fee waivers, and more. Cashback credit cards return a certain amount of money to users every month, depending on what they purchased. Store credit cards offer regular discounts and free shipping.

Even more credit card rewards include discounts or rebates from certain merchants, free rental car or travel insurance, purchase protection, and other perks. The list is nearly endless, and every rewards credit card has its own set of perks.

The important thing is to make sure you're using those perks. Credit card rewards are useless if you don't take advantage of them. Many rewards credit cards charge an annual fee, too, for the privilege of having access to those perks. If you pay an annual fee and don't take advantage of the rewards, you are wasting that money.

Don't sign up for a rewards credit card just for the sake of having one. Review the rewards and perks carefully before signing up, and decide if the benefits outweigh the negative card features (a high APR, for example, or a high annual fee). You want alignment between your behavior and the actual benefits of the credit card, too, Williams says, so make sure the rewards credit card your friend told you about fits into your lifestyle before you commit.

Just know that you may have a difficult time qualifying for a flash rewards credit card with great perks. "Annual fees typically go along with better rewards, and better rewards are typically reserved for credit cards that have a more stringent applicant process," Williams says.

Learn how to pick the best credit card for you.

If you're wondering which credit card is right for you, start by being honest with yourself: Will you be able to pay off your credit card balance every single month? If not, you'll want to look for a credit card with low fees and a low APR.

"With customers that are carrying a balance and getting charged interest, what they should be focused on is the interest rate," Kinane says. "The lower the better."

If you have a low credit score, you may want to look into secured credit cards. The key is to acknowledge that you will accumulate credit card debt and then look for ways to minimize that debt: High APRs and penalty fees will only increase the total amount you owe, making it more difficult to eventually become debt-free.

And remember: You don't need a credit card. They're convenient, they offer rewards, and they have some protections that other forms of payment don't, but if getting a credit card means accumulating debt or otherwise damaging your overall financial picture, you can skip it. Debit cards work just as well, and they're much easier to manage.

If you believe you will be able to pay off your credit card every month—or you plan to decrease your spending to make that possible—you have a few more options.

If you have low credit, you may not qualify for a fancy rewards credit card. Start with the lowest tier card—most offer some perks and no annual fee—and work on building credit by paying off your balance on-time, every month. Within a few months, you may be able to upgrade to a card with better rewards.

If you have a good credit score and a solid credit history, you have your pick of credit cards. Start by prioritizing what's important to you: Do you want a card that offers airline miles and other travel perks, or is a cash back card with no annual fee right for you?

"The first question I would ask myself if I were opening a credit card is, 'how much do I benefit?'" Williams says. "I encourage people to choose credit cards they think they'll benefit from the most." Take it this way: If you don't travel much, a travel rewards credit card is not right for you.

If you spend most of your money on groceries, pick a card that offers extra points for grocery spending. If you eat out every night, find a card that will reward you for that. Chances are, the right credit card for you is out there: You just have to find it. Do your research, take your time, and you'll have a great credit card in no time.

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