One of the most perplexing questions that prospective credit card applicants ask themselves is: should I try for the low-interest credit card or the rewards credit card?
For some consumers, this question is easily answered. For others, it may appear to be a coin toss.
The decision to apply for a credit card is not one to be taken lightly. As the infamous portal to impending debt, irresponsible usage can ruin one’s creditworthiness and cause years of financial hardship.
A common fork in the road for new card applicants includes a path towards low interest rates and a path towards rewards and cash back.
The crowd that never carries a balance would most likely tread towards rewards and cash back. Because credit card issuers do not charge interest when a balance is paid off entirely, this group has the luxury of not worrying about the APR.
The Safe Route
Cards that offer the opportunity to earn lucrative rewards and cash back usually come with higher APRs.
For example, the Blue Cash Everyday card from American Express has a regular APR of 17.24-22.24%. The card offers 3% cash back at supermarkets, 2% cash back at gas stations and department stores, and 1% on everything else.
Sure, the cash back is attractive but it’s a costly option for anyone who can’t pay off their balance.
An example of a scenario often encountered is when a card has a 11.99% APR with no rewards (e.g. Citi Platinum Select) or a card with 12.99% APR with 1% cash back (e.g. Citi Dividend Platinum Select).
The math wizard in us would assume that these cards are essentially equivalent. Of course, they’re not.
On a $5,000 balance (no further charges) at 11.99% APR and monthly payments of $200, the balance is paid off in 29 months and $782 is lost to interest costs.
On the same balance (no further charges) at 12.99% APR and monthly payments of $200, it’ll take 30 months to clear the balance and $862 is forfeited to interest costs. Even with the 1% cash back, the net loss is $812 – a $30 difference.
The culprit here is compounding, where the interest rate continues to apply to any remaining balance while the cash back is a one-time occurrence.
This difference can be reduced by making larger payments.
Under similar conditions as the above scenarios, at 11.99% APR with monthly payments of $500, the balance is paid off in 11 months and $295 paid in interest.
At 12.99% APR with monthly payments of $500, the balance is paid off in 11 months and $321 is lost to interest. With the 1% cash back, the net loss is $271 – actually less than the low-interest card.
However, this example should not be the single justification for choosing the rewards card.
The power to dispel credit card balances at a consistent rate is not within the capabilities of many consumers. If such a financial uncertainty may pose a problem, the low-interest credit card would be the wiser option.