Credit card offers can be both tempting and confusing, especially when it's hard to figure out how to make adequate "apples to apples" comparisons.
Let's say, for example, that you receive an offer to do a balance transfer, and the credit card company gives you two choices; you can enjoy a 0 percent annual percentage rate (APR) for 18 months, and pay a one-time-only fee of 3 percent for the balance transfer, or; you can perform a 24-month transfer to a card with no balance transfer fee, but comes with an APR of 4.99%. They both sound appealing, but are obviously quite different. How do you know which option to choose?
Key Pieces of Information
The key to almost all credit card offers boils down to four things. First is the APR. If that APR is a special introductory rate, then the second bit of information you need to know is when that intro rate expires. Unless you plan on paying off the entire balance before the offer expires, then the third thing you will want to know is what the APR will be after the introductory offer expires. The fourth piece of data is anything that represents an additional expense to you, such as an annual fee or a balance transfer fee.
Keep Calculations Simple
These things can be confusing because the length of the discounted APR rate is not the same, and neither is the amount of the transfer fee. To make it easier to compare both offers, reduce them to terms that can be viewed side-by-side. A shortcut to help with that is to convert the APR to a monthly number or cost.
Start by simply rounding numbers. Let's say the balance carried on the card is $1,000. If the APR is 10%, that means you will pay approximately 10% of your $1,000 balance in interest each year. That comes to $100 annually.
Next, you need to divide that number by 12, which will give you a rough idea of how much the interest charges are costing you per month. $100 divided by 12 = $8.30.
- If the APR is 4.99%, just round it up to 5%. That will give you50 per year in interest; roughly4 per month.
- For an APR of 2.99% you can round up to 3% - which gives you30 a year or2.50 per month.
In this way, you can simplify any APR to a ballpark estimate of how much interest it will cost you per month to carry a $1,000 balance. Since you also know the approximate monthly charges you can multiply that by how many months the introductory rate is offered for.
Don't Miss the Expiration
If you were comparing 0% for 18 months to 4.99% for 24 months, for instance, you would then know that at 4.99%, you'll wind up paying somewhere around $4 a month for 24 months or a total of about $96 in interest.
With the 0% offer there is a 3% surcharge, so to do a balance transfer of $1,000 would cost $30 ($1,000 X 3% = $30). That means that even after paying the surcharge you'll wind up paying about $66 dollars less with the 0% offer ($96-$30 = $66). That makes it look like the 0% offer is cheaper, but we cannot forget that the 0% expires six months sooner than the 4.99% offer which lasts for 24 months.
To factor that in and compare both offers over the full 24 months, find out what the APR will be after the 0% introductory rate expires. For example, if the on-going interest rate 15.99% after the introductory period, that means you'll be charged 15.99% for six months. Round the interest rate up to 16% to calculate the approximate APR, and divide by 12 months to get the monthly cost.
- $1,000 X 16% =160 a year or about13 a month. Now you know that paying the higher rate for six months will tack on approximately78 extra dollars in interest (13 X 6 =78).
- Comparing the offers with this extra information we see that the 0% is actually the more expensive option over 24 months, because it will wind up costing you78 plus a30 surcharge. That's a total of116 versus just96 with the 4.99% offer.
The key is to pay off your balance before the introductory rate expires. If you think you can pay it off within 18 months, then using our example, the total charges for the 0% 18-month offer will only be the $30 surcharge. If you need 24 months to pay if off, though, then the 4.99% offer will save you more - as long as you pay off that balance before it expires.
Sometimes pictures and charts can lay it all out in a visual way that is easier to understand. If you agree, check out our Understanding Credit Card Interest infographic for a step-by-step method to understanding your APR. Jason Steele also did a great job of explaining how to calculate credit card interest.
Knowing the math behind what your credit card company charges can help you become a more astute consumer. By really understanding what you're getting into, you can avoid getting ripped-off and take full advantage of the best offers available.