Don’t get a credit card before you figure this out

On average, each month Kiwis rack up about $4.2 billion in credit card transactions – either on shopping locally or using their card for shopping overseas. With the silly season just a few weeks away it can always be tempting to add on a credit card to your wallet. But, stop and consider this before you do so!

Credit cards come in all shapes and sizes. There are many factors for you to consider when shopping around for a credit card including which one earns you more Airpoints dollars, or which one has lower annual fees etc. You can find the best credit cards here – all it takes is a few minutes of your time.

But, perhaps the most important decision you have to make before you decide on a credit card is your own habits around credit card bill payments.

How credit cards work is pretty straightforward. You give your card details to the merchant. The merchant then sells you the product on the good faith that at some point in the future the bank who issued you the card will make good on the payment. At the same time, the bank expects you to repay that amount to them on a future date as well. The bank allows you a set number of days (typically between 44 and 55 days), to pay that amount. This means, all that has happened is you have pushed out when you make good on the payment for that product.

Your monthly credit card statement from the bank will highlight how much you have spent on your card in the most recent past period, the total amount you need to repay to the bank to settle the last periods purchases and the due date by which you need to make the payment.

If you don’t pay the entire amount of your monthly bill in full on or before the due date you will be charged a penalty. The penalty amount is worked out by applying the interest cost they charge on the entire amount of your outstanding balance. Penalty amounts can be substantial, typically averaging about 20%.

If you don’t want to end up paying this penalty you have to ensure that you pay the entire outstanding amount in full on or before the due date.

Some people are disciplined enough to ensure that in any given month they don’t spend more than what they know they can repay on the due date. Let’s call them ‘transactors’.

Some less disciplined users pile on to their credit card more than what they can repay in full at the end of the month. These rollover amounts accumulate over a period of months and years and quite easily become a death spiral without early intervention. Let’s call this group ‘rollers’.

What you look for in a credit card will depend mostly on whether you are a transactor or a roller.

For transactors, it doesn’t really matter whether the penalty interest rate on their credit card is higher or lower. Because they don’t intend to pay any penalty interest costs anyway. On the other hand, for the rollers, this is a critical criteria. Given their accumulating credit card balance they can end up paying larger and larger amounts of penalty amounts. So, they definitely should be looking at low interest rate cards.

For transactors, it really benefits them to have longer interest free periods. Because they are making the most of the borrowed time from the bank, the longer the period to due date (or the interest free days), the longer they can continue to use the bank’s money instead of their own. So, a card allowing 55 interest free days would be better than a card offering 44 interest free days for example. Relatively, this is not as much of a benefit to rollers.

So, first figure out your own repayment habits and then decide what criteria are important to you when choosing a credit card.

Find the best credit cards on PocketWise.

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