You may think you’re being rational when you pick out a new credit card or decide to stick with the same one you’ve owned for years. But if you’re like most people, there’s a good chance you’re walking around with a card that’s a less-than-perfect fit.
According to a new study out of Australia, most people are using the wrong piece of plastic for their spending – either because they overestimated how many rewards they’d earn from a particular card or because they underestimated how much money they’d spend on fees and interest.
How to avoid picking the wrong card
- Comb through the card’s terms and conditions.
- Calculate the value of the card’s rewards.
- Think seriously about how you’re going to use it.
- Re-evaluate any cards you’ve been using for a while.
Personal biases, blind spots lead us astray when card shopping
Researcher Mary-Alice Doyle dug into a large national survey of Australian consumers and found that people are often led astray by personal biases and blind spots when evaluating card offers and, as a result, wind up making significant mistakes.
For example, people often become overly optimistic about their ability to pay off their card balances in full and so they don’t pay attention to a new card’s interest rate; or they focus too narrowly on a card’s high rewards rate and mistakenly discount the true cost of its annual fee. Doyle found that many of the balance-carrying cardholders included in the survey could have saved hundreds of dollars a year just by switching to a lower rate card.
Some cardholders also give up potential earnings simply by picking a rewards card that doesn’t suit their habits.
For example, cardholders might pick a travel card because they dream of earning a free vacation; but they spend more money per year on groceries and gas and so would have earned more overall if they had picked an everyday rewards card. Similarly, cardholders might jump on an offer with a really big sign-up bonus; but then fail to charge enough throughout the year to gain enough points to offset a high annual fee.
“The monetary benefit that consumers receive from their credit card depends both on the way they use their card and on the particular card they choose,” writes Doyle. “To make an optimal card choice, consumers must first accurately estimate their own expected card use. Then, based on that expectation, consumers can choose the card that best suits their needs.”
See related: Which credit cards should I carry in my wallet?
How to avoid picking the wrong card
1. Hope for the best – but plan for the worst.
In other words: Don’t get overconfident. Too often, people embrace an overly sunny view of their financial abilities, or fail to take into account what can happen if they overcharge, says Doyle. As a result, they ignore key terms, such as a card’s standard interest rate, and focus instead on the fun stuff in a card offer, such as travel rewards or interest-free purchase periods.
The survey found more than half of the consumers who regularly carried a balance appeared not to have put any thought into how much that credit costs. Only 40 percent of consumers who regularly carry a balance said they evaluated the card’s interest rate when picking a card.
Before settling on a card, carefully comb through its terms and conditions. Don’t just look at the interest rate and annual fee. Also consider the card’s penalty rate, late fees and other charges that could trip you up if your finances take an unexpected hit.
2. Pull out your calculator before falling for a rewards program
Rewards programs are notoriously difficult to evaluate – especially since issuers often use their own idiosyncratic system for valuing rewards points and miles and redeeming what you’ve earned.
But it’s still worth taking the time to look at a rewards program more closely and calculate how much you think you’ll earn. You may find that a credit card offer isn’t nearly as generous as it seems.
For example, beware of getting seduced by inflated rewards rates – a common problem for cardholders. Many issuers offer an unusually large number of bonus points on select purchases in order to lure new customers. But the points are worth a fraction of the value of the average card rewards point.
You can calculate how much points are worth by looking at the number of points an issuer requires for a particular prize, such as a $100 gift card. Just divide the value of the reward – such as a gift card or hotel stay – by the number of points or miles it requires to redeem it.
Issuers don’t always provide this information to prospective cardholders, though, so you may also want to check reviews sites, such as CreditCards.com or The Points Guy, for recent estimates. Or you can use the average card value – 1 penny for every point you earn – as a general rule of thumb.
3. Consider your present – and your future – self
Take a hard look at your spending and think seriously about how you’ll actually use your card. Many people wind up with the wrong credit card because they didn’t think through how they’ll use it. Ask yourself what purchase categories you spend the most money on and calculate whether you’ll earn more rewards with a different card.
A card that offers 4 percent back on restaurant spending is great; but if you only eat out a few times a week, you probably won’t earn more than $5 to $10 a month. You may instead be better off with a card that awards you for paying for groceries. Similarly, if you aren’t willing to take the time to strategize your spending, you’re probably not going to get much out of a 5 percent cash back card with rotating bonus categories.
Don’t overestimate how much you’ll earn, either. According to Doyle, many people get in trouble by overestimating the rewards they’ll earn and underestimating the charges they’ll owe on their cards. If you think there’s a chance you’ll carry a balance, skip the rewards card and get a low rate credit card.
Or, consider carrying both and only use the rewards card for purchases you can afford to pay off. Similarly, don’t allow a big sign-up bonus or lengthy 0 percent introductory period temporarily blind you from other, more affordable offers. Many people focus too heavily on the present, says Doyle, and fail to think through the long term costs of a card.
See related:Cash back cards: How much can you really make?
4. Don’t get complacent with your current credit card
Longtime cardholders also tend to be reluctant to drop their current cards, says Doyle, or supplement them with new ones. As a result, they often wind up carrying around a card that was a great match years ago, but no longer suits their current lifestyle.
For example, they may still carry around a starter card with modest rewards, even though they’ve built a strong enough credit score to qualify for a more generous one. Or, they may stick to a high rate rewards card, even though their life circumstances have changed, and they need to carry a long-term balance.
Even cardholders who want to switch credit cards sometimes have a hard time pushing themselves to do so. Doyle found that roughly 20 percent of cardholders admitted that they had thought about switching cards that year, but hadn’t actually gotten around to it.
If your favorite card of years past no longer suits your lifestyle, take the time to research better options. You don’t necessarily need to ditch your old card completely. Keeping it open will benefit your credit score – especially if you’ve had it a long time. However, you’ll be better off if you pair it with a less expensive, or higher earning card.
Bottom-line: Picking a good credit card is often tougher than it looks – especially if you want to maximize your spending and earn rewards. Don’t be shy about thoroughly researching your options and considering what you want and need from a credit card. If the credit card you really want is a high rate rewards card, but you’re still carrying around a balance, then you may need to wait until you’re debt-free before you can afford your ideal card.