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When shopping for a mortgage, car loan or new credit card, you may be presented with an interest rate and an annual percentage rate -- each of which will show you the cost of the loan in a different way. Like with so many seemingly mundane financial details, the real-world implications of these two rates can add up to hundreds or thousands of dollars over time.
Knowing the crucial differences between the interest rate and APR will help you calculate your monthly payment, understand the total cost of a loan and, ultimately, identify the best deal. Here's why understanding how an APR impacts your loan -- especially in the context of a mortgage that can run into the hundreds of thousands of dollars -- is so important.
How interest rates work
An interest rate is the percentage of a loan you'll pay to the lender in exchange for borrowing money. With a mortgage, when you begin making monthly payments, interest is included in your payment. The actual rate you'll pay for a loan depends on a few factors.
Market trends
Interest rates are set by the Federal Open Market Committee (often referred to as "The Fed"), which is made up of representatives from the Federal Reserve. The Fed meets several times per year to discuss the state of the economy and adjust interest rates as needed. The Committee's job is to maintain healthy economic growth while keeping inflation at bay.
Currently, interest rates are at historic lows -- due in part to the coronavirus pandemic, but continuing a trend originating during the 2008 financial crisis. At the end of April 2021, the Fed decided to keep rates close to zero to keep financing as affordable as possible for businesses and individuals during this tough economic time.
Credit score
Your credit score also impacts the interest rate you're offered. Advertised interest rates are usually reserved for borrowers with excellent credit -- traditionally defined as a score of 760 or higher -- and may also include a rate discount for setting up automatic loan payments.
Individuals with a lower credit score (under 760) are usually offered higher interest rates to mitigate the lender's risk of losing money if the borrower defaults on their loan. A low credit score, a history of late payments or collection accounts can impact whether you're approved for a loan. And if you are approved, you'll likely be charged a higher interest rate than a borrower with good-to-excellent credit.
Most lenders recommend cleaning up your credit and finances before applying for a loan. Improving your credit score by paying down your debts and creating a history of on-time payments could save you thousands of dollars in interest on a mortgage.
For example, look at how a 0.5% difference in interest rates can change the total cost of a $300,000 loan over 30 years.
Interest paid at 3.00%: $155,332.36
Interest paid at 3.50%: $184,968.26
Though the numbers may be smaller for a credit card or car loan, modest differences in interest rates can add up over the years.
Other costs
In addition to your interest rate, there are other costs included in your home loan. The interest rate may be the most significant factor, but annual fees, closing costs and additional charges may add to the cost of borrowing money.
How annual percentage rate works
The annual percentage rate is typically higher than an interest rate because it includes all the costs of borrowing money. Some fees that may be incorporated into the APR are:
Points (one point is equal to 1% of the loan)
Loan-processing and administrative fees
Underwriting fee
Escrow or loan settlement fee
Private mortgage insurance (for mortgages)
Document-preparation fee
Annual fee (for credit cards)
While you may not always be able to negotiate your interest rate, you may be able to negotiate some of the fees included in your APR. The fewer the charges associated with the loan, the lower the APR.
Lenders must legally display their APR
The Truth in Lending Act was enacted in 1968 to make credit cards and loans more transparent, so buyers know what they're comparing -- and signing up for. One of the Act's requirements is that lenders must report APR, which reflects the extra costs of borrowing more accurately. You'll find the APR advertised alongside the interest rate. You can also find it in the Loan Estimate. The interest rate is usually shown on page one under "Loan Terms," and the APR usually appears on page three under the "Comparisons" section.
Fixed vs. variable APR
A fixed APR does not change. But a variable rate APR can fluctuate based on index rate changes, such as the Wall Street Journal's published prime rate. Some variable APRs -- penalty APRs -- can also change as a penalty if you make late payments.
How loan terms impact APR
The loan terms you choose will also impact the amount of interest and other fees you'll pay over the lifetime of your mortgage. You'll typically be able to make lower monthly payments and pay less monthly interest and fees with a 30-year mortgage than with a 15-year home loan. But, since you'll be making this payment for twice the amount of time, you'll ultimately pay more in interest. Generally, you'll pay less interest and fees overall with a shorter mortgage term.
Here's an example of how a loan term can impact your APR, based on a $250,000 home loan.
How loan term impacts APR
Option A: 3.25% interest rate, 15 years
Option B: 3.25% interest rate, 30 years
Option C: 3.75% interest rate, 15 years
Option D: 3.75% interest rate, 30 years
Cost of points and fees
$2,500
$2,500
$1,200
$1,200
APR
3.43%
3.35%
3.84%
3.80%
Monthly payment
$1,405.34
$870.41
$1,454.44
$926.23
Total interest paid
$52,960.76
$113,348.55
$61,800.08
$133,443.23
In this example, Option B has the lowest APR -- 3.350% for a 30-year loan term -- and may seem like the best choice at first glance. The monthly payment is the smallest at $870.41, over $500 cheaper per month than Option A. However, because Option B is spread out across 30 years, you'll pay more than double the amount of interest than you would with Option A.
Interest rate vs. APR: Which one should you use when mortgage shopping?
Bottom line: Interest rates are only part of the picture. When you're shopping for a mortgage or any other type of loan, comparing APR rates across lenders will give you the most accurate and complete view of your costs. A lender could advertise the lowest interest rate yet charge a higher APR, costing you more money in interest in the long term.
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What Is Home Equity?
Most homeowners now have more equity in their homes than they did two years ago, thanks to surging home values during the pandemic. That means right now is a good time to consider tapping into your home equity if you're looking to borrow money at a lower interest rate than you might get with other types of loans such as personal loans. Home equity is the difference between what you owe on your mortgage and the current market value of your home.
You build equity in your home by consistently making mortgage payments over the years. Equity is valuable because it allows you to borrow money against your home at lower interest rates than other types of financing. Once you have enough equity built up in your home, lenders and banks will allow you to borrow against it. Some of the most common reasons to borrow against your equity are to pay for life expenses such as home improvements, higher education costs such as tuition, or to pay off high-interest credit card debt.
Most lenders want to see that you've built up at least 15% to 20% in equity in order to let you borrow money against your house in the form of refinancing or other kinds of home equity loans. One of the simplest ways to ensure you have a good chunk of equity in your home is to make a large down payment if you are able to.
For a typical homeowner with a 30-year fixed-rate mortgage, building up 15% to 20% usually takes about 5 to 10 years. Even if you paid less for your home when you bought it years ago, your equity is based on the present-day value of your house. If, for example, your home is currently worth $500,000 and you have $400,000 left to pay on your mortgage, you would have $100,000 of equity in your home.
Here's what you need to know about home equity, what it is, how to calculate it and why it's important to homeowners.
How do you calculate home equity?
To calculate your home equity, simply subtract your remaining mortgage balance from the current market value of your home. So if you owe $400,000 on your mortgage and your house is worth $500,000, you have $100,000, or 20% equity in your home. You may need to work with an appraiser or real estate agent in order to get an accurate evaluation of your home's fair market value, especially since home values have risen by record-breaking amounts since the beginning of the pandemic.
Ways to borrow against home equity
There are various ways to access the equity in your home. Some of the most common equity financing options are home equity loans, home equity lines of credit (or HELOCs) and reverse mortgages. It's important, however, to keep in mind that all of these options require you to put up your home as collateral to secure the loan, so it's critical to understand that there's a risk of losing your home to foreclosure if you miss payments or default on your loan for any reason.
Home equity loan
A home equity loan lets you borrow money against the equity you've built in your home and provides you with a lump sum of cash at a fixed interest rate. Lenders typically want to see that you have at least 15% to 20% in your home to approve you for a home equity loan. A home equity loan doesn't replace your mortgage like a refinance, rather, it's an entirely new loan that you'll repay monthly along with your existing mortgage payment. But just like a mortgage, with a home equity loan, your interest rate never changes and your monthly payments are fixed, too.
HELOCs
A home equity line of credit, or HELOC, is a type of loan that lets you borrow against the equity you've built up in your home and functions like a credit card. It provides you with an open line of credit that you can access for a certain amount of time, typically 10 years, followed by a set repayment period, which is usually 20 years. Lenders also generally want you to have at least 15% to 20% in your home for HELOC approval. With a HELOC, you don't have to take all of your funds out at once, and you can withdraw money repeatedly from your HELOC over the 10-year period, once previously borrowed sums are paid back.
"A HELOC offers more flexibility than a home equity loan -- you can't withdraw money from a home equity loan like you can with a HELOC, and a HELOC allows you to receive replenished funds as you pay your outstanding balance," said Robert Heck, VP of Mortgage at Morty, an online mortgage marketplace.
HELOCs have variable interest rates however, so it's important to make sure you can afford higher monthly payments if your rate goes up once your introductory interest rate expires, especially in the current economic climate.
Reverse mortgage
You must be 62 years or older to access a reverse mortgage and have either paid off your home or have significant equity accumulated, usually at least 50%. With a reverse mortgage, you do not have to make monthly mortgage payments and the bank or lender actually makes payments to you. You must still pay your property taxes and homeowners insurance and continue to live in the house, however. A reverse mortgage allows you to access the equity in your home and not pay back the funds for an extended period of time while using them for other expenses during retirement. It's important to keep in mind that you are building a mortgage balance back up as you borrow against your equity, and your estate will eventually have to pay off your loan. A common way to repay this loan is to sell your house.
The bottom line
Unlocking the equity in your home can be a valuable way to access financing to cover other life expenses. It's important to understand the differences between the kinds of equity loans available to secure the best one for your particular financial situation. When comparing ways to access equity, always take into account the interest rate, additional lender costs and fees, and the size of the loan and how it will be disbursed to you, as well as the amount of time you have to pay it back, before you enter into an agreement to borrow against the equity in your home.
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Home Equity Loan Rates for September 2022
Home Equity Loan Rates for September 2022
With record-breaking home appreciation seen throughout the pandemic, most homeowners have more equity in their homes now compared to two years ago. If you need access to funds for a renovation project, education expenses or even debt consolidation, tapping into your home's equity could provide you with a lower-rate financing option. A home equity loan, which lets you borrow money against the equity you've built in your home, provides you with a lump sum of cash at a fixed interest rate.
Home equity loans may be particularly appealing in the current economic climate. Mortgage rates overall have gone up more than 2% since the beginning of the year. Even though rates recently dipped as the Federal Reserve increased its benchmark interest rate for the fourth time this year in an attempt to combat rising inflation, home equity loans still tend to offer lower interest rates than other types of loans. That's a significant benefit for anyone looking for financing at a time when it's uncertain how much rates will fluctuate moving forward.
This type of financing may make sense if you own a home and have at least 15% to 20% of equity built up in your home. Unlike a home equity line of credit, or HELOC, you'll receive the sum of the loan upfront in one lump payment if you're approved.
A home equity loan is a lower interest rate financing option, but it's not without risk. When you secure a home equity loan, your home acts as collateral, which means you could lose your home if you're unable to repay what you borrowed. It's important to carefully consider whether a home equity loan is right for you before applying for financing.
Here's everything you should know about home equity loans, how they work, who they're best for and how they compare to other loan options.
What is a home equity loan?
A home equity loan offers you a lump sum of cash you borrow against the equity built in your house. Tapping into your home's equity means you are borrowing against the mortgage payments you've already made -- it won't replace your existing mortgage payment -- it's a new loan that you'll repay monthly, along with your existing home loan.
Most lenders require you to have 15% to 20% of equity in your home to secure a home equity loan. To figure out how much equity you have, subtract your remaining mortgage balance from the value of your home. For example, if you have a $500,000 mortgage and you owe $350,000 on it, you have $150,000 in equity. To figure out the percentage, divide this number ($150,000) by your home's value ($500,000) and you'll see you have 30% equity available in your home. Lenders will typically let you borrow around 80% to 85% of your home's equity for a home equity loan. So, in this case, you could borrow up to $120,000 to $127,500.
A standard repayment period for a home equity loan is between five to 30 years for a home equity loan. You make fixed-rate payments that never change, which means even if interest rates go up, your loan rate is locked in.
Current home equity loan rate trends
One of the benefits of home equity loans is that they typically have lower interest rates than personal loans or credit cards. Right now, borrowers with good credit and sufficient equity can secure home equity loans with interest rates as low as 3%, according to Bankrate, which is owned by the same parent company as CNET.
One potential downside of a home equity loan is that if your property value goes down for any reason, you could end up underwater on your loan. This happens when the balance of your loan becomes higher than the value of your home. That's what happened to millions of Americans during the 2008 financial crisis. Right now, there's less risk of your home's value decreasing below your home equity loan amount, though. Home prices have appreciated as much as 20% in some metro areas across the US over the last two years, and it seems unlikely that they will go down in a significant way anytime soon.
Pros of a home equity loan
Fixed-rate payments: Your monthly payment will never change even if interest rates rise.
One lump sum of cash: You receive the entire loan upfront in one disbursement.
Low interest rates: It has a lower interest rate than other types of personal loans or credit cards.
Tax deductible interest: If you use it for home renovations, you can deduct the interest from your taxes.
Cons of a home equity loan
Using your home as collateral: If you fail to make your payments or default on your loan, your lender can foreclose and take ownership of your house.
Can take longer to receive the funds: It can take more time to receive a home equity loan than a personal loan, for example.
Closing costs are expensive: Closing costs can range anywhere from 2% to 5% of the loan.
Your home's value could decrease after receiving your loan: Although home values are not expected to decrease significantly any time soon, if your home's value were to drop below your home equity loan amount, you would have what is known as negative equity. Negative equity means you owe more than your home is worth. So, if you were to sell your home, you likely would not receive enough money from a seller to pay off your loan balance.
Home equity loans vs. HELOC
Home equity loans and home equity lines of credit, or HELOCs, are similar, but have a few key distinctions. Both let you draw on your home's equity and require you to use your home as collateral to secure your loan. The two major differences between a home equity loan and a HELOC are the way you receive the money and how you pay it back.
A home equity loan gives you the money all at once as a lump sum, whereas a HELOC lets you take money out in installments over a long period of time, typically ten years. Home equity loans have fixed-rate payments that will never go up, but most HELOCs have variable interest rates that rise and fall with the economy and overall interest-rate trends.
A home equity loan is better if:
You want a fixed-rate payment: Your monthly payment will never change even if interest rates rise.
You want one lump sum of money: You receive the entire loan upfront with a home equity loan.
You know the exact amount of money you need: If you know the amount you need and don't expect it to change, a home equity loan likely makes more sense than a HELOC.
A HELOC is better if:
You need money over a long period of time: You can take the money as you need it and only pay interest on the amounts you withdraw, not the full loan amount, as is the case with a home equity loan.
You want a low introductory interest rate: Although HELOC rates may increase over time, they also typically offer lower introductory interest rates than home equity loans. So, you could save money on interest charges.
Home equity loans vs. cash-out refinances
A cash-out refinance is when you replace your existing mortgage with a new mortgage, typically to secure a lower interest rate and more favorable terms. Unlike a traditional refinance, though, you take out a new mortgage for the home's entire value -- not just the amount you owe on your mortgage. You then receive the equity you've already paid off in your home as a cash payout.
For example, if your home is worth $450,000 and you owe $250,000 on your loan, you would refinance for the entire $450,000, rather than the amount you owe on your mortgage. Your new cash-out refinance home loan would replace your existing mortgage, and then offer you a portion of the equity you built (in this case $200,000) as a cash payout.
Both a cash-out refi and a home equity loan will provide you with a lump sum of cash that you'll repay in fixed amounts over a specific time period, but they have some important differences. A cash-out refinance replaces your current mortgage payment. When you receive a lump sum of cash from a cash-out refi, it is added back onto the balance of your new mortgage, usually causing your monthly payment to increase. A home equity loan is different -- it does not replace your existing mortgage and instead adds an additional monthly payment to your expenses.
A home equity loan is better if:
You do not want to pay private mortgage insurance: Some cash-out refinances require PMI, which can add hundreds of dollars to your payments, but home equity loans do not.
You can't complete a refinance: With rates rising, it's possible that your mortgage rate is lower than current refinance rates. If that's the case, it likely won't make financial sense for you to refinance. Instead, you can use a home equity loan to only take out the money you need, rather than replacing your entire mortgage with a higher interest rate loan.
A cash-out refinance is better if:
Refinance rates are lower than your current mortgage rate: If you can secure a lower interest rate by refinancing, this could save you money in interest, while providing access to a lump sum of cash.
You only want one monthly payment: The amount you borrow gets added back to the balance of your mortgage so you only make one payment to your lender every month.
Less stringent eligibility requirements: If you don't have great credit or you have a high debt-to-income ratio, you may have an easier time qualifying for a cash-out refi compared to a home equity loan.
Lower interest rates: Cash-out refinances sometimes offer more favorable interest rates than home equity loans.
FAQs
What is a good home equity loan rate?
Right now, lenders are offering rates that start as low as around 3% for borrowers with good credit, but rates vary depending on your personal financial situation. A lender will base your interest rate on how much equity you have in your home, your credit score, income level and other aspects of your financial life such as your debt-to-income ratio, which is calculated by dividing your monthly debts by your gross monthly income.
How do I qualify for a home equity loan?
You are typically required to have at least 15% to 20% equity built up in your home to qualify for a home equity loan. You must also have enough income and a low-enough debt-to-income ratio to qualify -- lenders usually want to see a DTI of 43% or below. Lenders also like to see a minimum credit score of at least 620. Generally speaking, if your credit score is below 700 there is a possibility that a lender will deny you for a home equity loan. The better your credit, the better your chances of being approved for a loan with a low interest rate.
What can I use a home equity loan for?
Home equity loans can be used for anything you choose to spend the money on. Typical life expenses that people usually take out home equity loans to cover are expenditures like home renovations, higher education costs like tuition or to pay off high-interest debt like credit card debt. There's a bonus for home improvements: If you use a home equity loan for renovations, the interest is tax deductible.
You can also use a home equity loan in an emergency situation or for life events like weddings. But keep in mind that whatever you chose to use a loan for, taking out a large sum of money that accrues interest is an expensive choice you should always carefully consider – especially since you're using your home as collateral to secure the loan. If you can't pay it back, the lender could seize your home to repay your debt.
How do I apply for a home equity loan?
Applying for a home equity loan is similar to applying for a mortgage. You need to qualify with a lender or bank who is willing to lend you the money. First, the lender will first want to make sure you have at least 15% to 20% equity in your home. If you do, the lender will take into account your credit score (lenders usually like to see a minimum score of 620), your income and your current debt-to-income ratio to determine whether you qualify and what your interest rate will be. You should be prepared to have financial documents like pay stubs and W2s in order, as well as proof of ownership and proof of the appraised value of your home. It's important to interview multiple lenders to determine which lender can offer you the lowest rates and fees.
More mortgage tools and resources
You can use CNET's mortgage calculator to help you determine how much house you can afford. The CNET mortgage calculator factors in variables such as the size of your down payment, home price and interest rate to help you understand how much of a difference even a slight increase in rates can make in the amount of interest you'll pay over the lifetime of your loan.
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The Worst Credit Card Mistakes You Should Stop Making
The Worst Credit Card Mistakes You Should Stop Making
There are several important benefits of using a credit card to shop. You can earn rewards, build your credit and take advantage of travel points and perks. But while shopping with a credit card can be convenient, there are also certain risks you need to be aware of.
If you pay a card late or don't pay your balance in full, you can incur fees and extra interest charges that make your purchases more expensive in the long run, especially considering today's rising interest rates, fueled by skyrocketing inflation. You could also wind up jeopardizing your credit score, which could make it harder to buy a house or get a loan.
So what are the biggest mistakes well-meaning people commonly make with their credit cards -- and what can you do to avoid financial pitfalls? I spoke with experts for their suggestions, and identified some of the most dangerous credit card behaviors. For more, learn how to get out of credit card debt and why now is the right time to pay off your credit cards.
Paying your credit card bill late
Missing a payment or making a late payment on a credit card is a major no-no. Colleen McCreary, a consumer financial advocate at Credit Karma, says this is the most common mistake people make with credit cards. Your payment history is a major factor of your credit rating and accounts for more than 30% of your overall score, McCreary said in an email.
A late payment is a one-way ticket to ruining your credit, and the ding on your report won't go away for seven years. Even worse, if your credit card bill remains unpaid, your creditor could sell your debt to a collection agency, which could tank your credit rating.
The best way to avoid late fees is to set a monthly reminder to pay your bill, and at least make the minimum payment. Most credit card companies will also let you set up monthly auto-payments, so you won't skip a beat. If you're worried you may not have enough each month to cover an autopayment, remember you can always set it to pay out the minimum, the full balance or a specified amount.
The credit bureau Experian notes that some credit card issuers may provide a short grace period for late payments, while others will mark your payment late as soon as you miss your due date.
If you do pay your credit card bill on time regularly and accidentally miss one payment, call your bank as soon as possible to see if it will offer one-time forgiveness, provided you pay in full at the time of your call. Your bank might refund your late fee and interest, but it isn't required to do anything.
While some credit card companies may mark your payment late after one day, those late payments are not reported to credit bureaus for 30 days, according to credit reporting company Equifax, If you act quickly to change your issuer's decision to mark your payment late, you could avoid damaging your credit score. If you're unable to pay your bill, you can also ask your issuer if it can create a payment plan for you.
Stop paying your credit card bill late
Sarah Tew/CNET
Maxing out your credit cards
After payment history, the second biggest factor in determining your credit score is the percentage of available credit that you are currently using. Called the "credit utilization ratio," this factor is calculated by dividing the amount you currently owe by your total credit limit, or your maximum borrowing potential.
Maintaining a high balance on your credit card compared to your total credit limit will increase your total percentage of credit used and hurt your credit score.
You usually want to keep your credit utilization ratio under 30% for a good credit score, though less is better. A good rule of thumb is to use 10% of your total credit limit and pay it off each month so you're not carrying a balance. For example, if your credit limit is $5,000, you wouldn't want to borrow more than $1,500 and ideally $500 or less.
If you find your credit card limit is too low -- for example, the amount you want to charge to your card exceeds the total you can charge on a given card -- you can always ask your credit card issuer for an increase.
Maxing out credit cards could also cost you big money if you can't pay off the total by the payment deadline. "The higher your outstanding balance (the amount of money you owe), the more interest you'll pay, which can make it even more difficult to climb out of debt," McCreary said.
Making only the minimum payment on your credit card
Your minimum payment is the lowest amount that your credit card issuer will allow you to pay toward your credit card bill for any given month -- for example, $50. The minimum monthly payment is determined by the balance on your credit card (what you owe at the end of the pay period) and your interest rate. It's generally calculated as either 2 to 4% of your balance, a flat fee or the higher amount between the two.
Making only minimum payments is one of the most common credit card mistakes, according to Katie Bossler, a quality assurance specialist at GreenPath financial wellness.
Although making minimum payments on time is still far better than paying late or ignoring your bill, paying only the minimum can cause interest to build, making it much more difficult to pay off your balance completely.
For example, if you have a $2,000 balance with a minimum payment of $50 on a credit card with an APR (annual percentage rate) of 14.55%, it will take 56 months (or almost five years) to pay off your debt, and you'll end up paying a total of $753 in interest. However, if you make a plan to pay the balance off in a year, your payments would be $180, and you'd only pay $161 in interest.
It only gets worse as the APR goes up -- at a relatively high but not unreasonable rate of 25%, a minimum payment of $50 would take 87 months (or a little more than seven years) to pay off a $2,000 debt, with a sizable $2,344 in interest payments. Meanwhile, upping the monthly payments to the same $180 would pay off your debt in 13 months, and cost only $281 in interest.
Here's an example of how making more than minimum payments can save you significant money in interest.
How minimum payments lead to higher interest
Credit card balance
Annual percentage rate
Monthly payment
Time needed to pay balance
Additional interest paid
$2,000
14.55%
$50
4.7 years
$753
$2,000
14.55%
$180
1 year
$161
$2,000
25%
$50
7.3 years
$2,344
$2,000
25%
$180
1.1 years
$281
The best way to avoid paying any interest at all on your credit cards is to pay off your full balance each month. If you can't do that, Bossler, the quality expert from GreenPath financial advisors, suggests pausing use of the credit card while you're paying it off, and paying more than the minimum to do so.
Taking out a cash advance on your credit card
Withdrawing a cash advance with a credit card is a big mistake. "It's the most expensive way to pay for things," Bossler said. Cash advances are a method of borrowing money from your credit line to put cash in your pocket "now."
Convenient as it may be, a cash advance uses an interest rate that is typically significantly higher than your standard APR. Most cards will also include a transaction fee of 3 to 5%. "This is not the way to go," Bossler said.
If you receive a "convenience check" in the mail from a credit card company, be careful. It could be a cash advance offer that's best tossed in the recycle bin. If you need some extra cash, it might be better to think about starting a side hustle or taking out a personal loan with a lower interest rate. Budgeting apps can also help track your spending, so you can pull back on expenses that can wait.
Chasing credit card rewards with abandon
If you're thinking of opening a new credit card account to get money back on your purchases, you can best manage rewards by considering your lifestyle. Heavy travelers should look for a card with frequent flyer rewards. If you spend a lot of money on groceries or drive your car often, look for cash back rewards for spending at gas stations and grocery stores.
However, you shouldn't make spending decisions based on receiving rewards. "Credit cards shouldn't be used as a strategy for buying things," Bossler said. Many cards will require a minimum amount of purchases for special rewards, or a welcome bonus to tempt you into spending more than you can afford.
Credit cards with lucrative rewards can also charge higher annual fees, for example, $100 or even $500 a year. If you're not spending enough to earn that annual cost back in rewards, you might consider a card with no annual fee.
Credit card rewards can be a powerful financial tool when used wisely, but you'll need to be careful to avoid running up your balance. Thomas Nitzsche, senior director of Media and Brand at MMI, says he often sees people making the mistake of using credit cards for rewards while ignoring the growing interest on their balance. If you're chasing rewards at the expense of your budget, consider coming up with a plan to pay your balance down instead.
Your credit score can drop when you cancel your credit cards.
Sarah Tew/CNET
Not paying off big purchases during a 0% APR period
Whether you just opened a 0% APR credit card -- which offers interest-free debt for a specific promotional period -- or a balance transfer card -- a credit card designed to accept debt from other cards -- make sure you read the fine print. Oftentimes, there's a fee to transfer your existing balance, commonly 3% of the balances transferred. Also, the introductory 0% rate only lasts for so long, typically between six and 18 months. That means you've got a limited time to pay off your balance before a higher APR kicks in. (When it does, your monthly interest gets a lot more expensive.)
To create a simple repayment plan, take the amount you owe and divide it by the number of months in your 0% APR promo period. Then pay that amount monthly to completely pay off your balance while you are borrowing without interest. For example, if you buy a $300 TV using a credit card with 0% APR for six months, making $50 monthly payments will eliminate your debt before the no-interest period expires.
Using a 0% intro APR credit card can be a good strategy to pay off your debt or finance a large purchase, but it can be risky, too. While disciplined borrowers can effectively roll balances into new accounts with 0% intro APR, Nitzche says that many people who transfer their credit card balances only make minimum payments, which can result in spiraling debt and damaged credit, leading to a point when they can no longer get approval for new accounts.
Canceling your credit cards
Even if you have paid down your balance on a credit card, there are two big reasons why you shouldn't cancel your account. Closing your account would affect your length of credit history and credit utilization ratio, two important components of your credit score. (Remember, your credit utilization ratio is the percentage of your total available credit lines across all cards you're using.)
If you close an account you're not using, your total available credit line shrinks, making your credit utilization ratio higher.
Canceling older credit cards will also shorten your credit history, leading to a significant drop in your credit score. If you do decide to cancel some of your credit cards, it's best to leave the oldest account open, as well as the one with the highest credit limit to maintain your credit utilization ratio and prevent any damage to your credit score.
It's important to note that with inactivity, credit card issuers may automatically close your account. To avoid this, Nitzche says that it's best to use each of your credit cards once in a while for small purchases.
Applying for too many credit cards
You may have heard this advice before: Don't apply for too many credit cards at once. Each time you apply for a new credit card, your credit score can drop slightly due to a "hard" credit check.
Hard credit checks require your consent and involve a full credit summary from a credit bureau. "Soft" credit checks occur when you view your credit report or a financial company requests a summary without your consent, and they don't affect your credit score. They're used for purposes such as preapproved credit card offers.
When you authorize lenders to pull your credit history, you'll see a "hard" inquiry on your credit report. According to credit score company MyFICO, a hard pull will lower your credit score by about 5 points. While it will stay on your report for two years, the deduction to your score will usually be eliminated within a year.
Too many hard pulls on your credit in a short amount of time -- for example, applying for five store credit cards in one weekend -- could affect your credit rating more, as multiple inquiries indicate higher risks of insolvency or bankruptcy. Experian suggests waiting at least six months between applying for new lines of credit to avoid lowering your credit score.
Applying for too many credit cards at once can drop your credit score.
Sarah Tew/CNET
Not checking your billing statements regularly
How often do you check your monthly billing statement? It can be an eye opener to see how much money you really charge your credit card, especially if it's routinely more than you bring home each month.
Spending $20 here and there may not seem like a huge amount, but it can add up quickly. Remember that increasing your credit utilization ratio (your percentage of credit used) will lower your credit score and high balances will cost you more in interest. Plus, how do you know how much you've charged if you aren't tracking your spending?
Tracking your credit card spending isn't the only reason to check your billing statement. You should thoroughly comb through your transactions to make sure there aren't any potentially fraudulent charges you didn't make. The sooner you discover you're a victim of identity fraud, the sooner you can contact your card issuer to dispute the charges and take the necessary steps to secure your credit card account.
For more tips on using credit cards wisely, learn six ways to get the most from your credit card and how to pick the right credit card.
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The Worst Credit Card Mistakes You Should Stop Making
The Worst Credit Card Mistakes You Should Stop Making
There are several important benefits of using a credit card to shop. You can earn rewards, build your credit and take advantage of travel points and perks. But while shopping with a credit card can be convenient, there are also certain risks you need to be aware of.
If you pay a card late or don't pay your balance in full, you can incur fees and extra interest charges that make your purchases more expensive in the long run, especially considering today's rising interest rates, fueled by skyrocketing inflation. You could also wind up jeopardizing your credit score, which could make it harder to buy a house or get a loan.
So what are the biggest mistakes well-meaning people commonly make with their credit cards -- and what can you do to avoid financial pitfalls? I spoke with experts for their suggestions, and identified some of the most dangerous credit card behaviors. For more, learn how to get out of credit card debt and why now is the right time to pay off your credit cards.
Paying your credit card bill late
Missing a payment or making a late payment on a credit card is a major no-no. Colleen McCreary, a consumer financial advocate at Credit Karma, says this is the most common mistake people make with credit cards. Your payment history is a major factor of your credit rating and accounts for more than 30% of your overall score, McCreary said in an email.
A late payment is a one-way ticket to ruining your credit, and the ding on your report won't go away for seven years. Even worse, if your credit card bill remains unpaid, your creditor could sell your debt to a collection agency, which could tank your credit rating.
The best way to avoid late fees is to set a monthly reminder to pay your bill, and at least make the minimum payment. Most credit card companies will also let you set up monthly auto-payments, so you won't skip a beat. If you're worried you may not have enough each month to cover an autopayment, remember you can always set it to pay out the minimum, the full balance or a specified amount.
The credit bureau Experian notes that some credit card issuers may provide a short grace period for late payments, while others will mark your payment late as soon as you miss your due date.
If you do pay your credit card bill on time regularly and accidentally miss one payment, call your bank as soon as possible to see if it will offer one-time forgiveness, provided you pay in full at the time of your call. Your bank might refund your late fee and interest, but it isn't required to do anything.
While some credit card companies may mark your payment late after one day, those late payments are not reported to credit bureaus for 30 days, according to credit reporting company Equifax, If you act quickly to change your issuer's decision to mark your payment late, you could avoid damaging your credit score. If you're unable to pay your bill, you can also ask your issuer if it can create a payment plan for you.
Stop paying your credit card bill late
Sarah Tew/CNET
Maxing out your credit cards
After payment history, the second biggest factor in determining your credit score is the percentage of available credit that you are currently using. Called the "credit utilization ratio," this factor is calculated by dividing the amount you currently owe by your total credit limit, or your maximum borrowing potential.
Maintaining a high balance on your credit card compared to your total credit limit will increase your total percentage of credit used and hurt your credit score.
You usually want to keep your credit utilization ratio under 30% for a good credit score, though less is better. A good rule of thumb is to use 10% of your total credit limit and pay it off each month so you're not carrying a balance. For example, if your credit limit is $5,000, you wouldn't want to borrow more than $1,500 and ideally $500 or less.
If you find your credit card limit is too low -- for example, the amount you want to charge to your card exceeds the total you can charge on a given card -- you can always ask your credit card issuer for an increase.
Maxing out credit cards could also cost you big money if you can't pay off the total by the payment deadline. "The higher your outstanding balance (the amount of money you owe), the more interest you'll pay, which can make it even more difficult to climb out of debt," McCreary said.
Making only the minimum payment on your credit card
Your minimum payment is the lowest amount that your credit card issuer will allow you to pay toward your credit card bill for any given month -- for example, $50. The minimum monthly payment is determined by the balance on your credit card (what you owe at the end of the pay period) and your interest rate. It's generally calculated as either 2 to 4% of your balance, a flat fee or the higher amount between the two.
Making only minimum payments is one of the most common credit card mistakes, according to Katie Bossler, a quality assurance specialist at GreenPath financial wellness.
Although making minimum payments on time is still far better than paying late or ignoring your bill, paying only the minimum can cause interest to build, making it much more difficult to pay off your balance completely.
For example, if you have a $2,000 balance with a minimum payment of $50 on a credit card with an APR (annual percentage rate) of 14.55%, it will take 56 months (or almost five years) to pay off your debt, and you'll end up paying a total of $753 in interest. However, if you make a plan to pay the balance off in a year, your payments would be $180, and you'd only pay $161 in interest.
It only gets worse as the APR goes up -- at a relatively high but not unreasonable rate of 25%, a minimum payment of $50 would take 87 months (or a little more than seven years) to pay off a $2,000 debt, with a sizable $2,344 in interest payments. Meanwhile, upping the monthly payments to the same $180 would pay off your debt in 13 months, and cost only $281 in interest.
Here's an example of how making more than minimum payments can save you significant money in interest.
How minimum payments lead to higher interest
Credit card balance
Annual percentage rate
Monthly payment
Time needed to pay balance
Additional interest paid
$2,000
14.55%
$50
4.7 years
$753
$2,000
14.55%
$180
1 year
$161
$2,000
25%
$50
7.3 years
$2,344
$2,000
25%
$180
1.1 years
$281
The best way to avoid paying any interest at all on your credit cards is to pay off your full balance each month. If you can't do that, Bossler, the quality expert from GreenPath financial advisors, suggests pausing use of the credit card while you're paying it off, and paying more than the minimum to do so.
Taking out a cash advance on your credit card
Withdrawing a cash advance with a credit card is a big mistake. "It's the most expensive way to pay for things," Bossler said. Cash advances are a method of borrowing money from your credit line to put cash in your pocket "now."
Convenient as it may be, a cash advance uses an interest rate that is typically significantly higher than your standard APR. Most cards will also include a transaction fee of 3 to 5%. "This is not the way to go," Bossler said.
If you receive a "convenience check" in the mail from a credit card company, be careful. It could be a cash advance offer that's best tossed in the recycle bin. If you need some extra cash, it might be better to think about starting a side hustle or taking out a personal loan with a lower interest rate. Budgeting apps can also help track your spending, so you can pull back on expenses that can wait.
Chasing credit card rewards with abandon
If you're thinking of opening a new credit card account to get money back on your purchases, you can best manage rewards by considering your lifestyle. Heavy travelers should look for a card with frequent flyer rewards. If you spend a lot of money on groceries or drive your car often, look for cash back rewards for spending at gas stations and grocery stores.
However, you shouldn't make spending decisions based on receiving rewards. "Credit cards shouldn't be used as a strategy for buying things," Bossler said. Many cards will require a minimum amount of purchases for special rewards, or a welcome bonus to tempt you into spending more than you can afford.
Credit cards with lucrative rewards can also charge higher annual fees, for example, $100 or even $500 a year. If you're not spending enough to earn that annual cost back in rewards, you might consider a card with no annual fee.
Credit card rewards can be a powerful financial tool when used wisely, but you'll need to be careful to avoid running up your balance. Thomas Nitzsche, senior director of Media and Brand at MMI, says he often sees people making the mistake of using credit cards for rewards while ignoring the growing interest on their balance. If you're chasing rewards at the expense of your budget, consider coming up with a plan to pay your balance down instead.
Your credit score can drop when you cancel your credit cards.
Sarah Tew/CNET
Not paying off big purchases during a 0% APR period
Whether you just opened a 0% APR credit card -- which offers interest-free debt for a specific promotional period -- or a balance transfer card -- a credit card designed to accept debt from other cards -- make sure you read the fine print. Oftentimes, there's a fee to transfer your existing balance, commonly 3% of the balances transferred. Also, the introductory 0% rate only lasts for so long, typically between six and 18 months. That means you've got a limited time to pay off your balance before a higher APR kicks in. (When it does, your monthly interest gets a lot more expensive.)
To create a simple repayment plan, take the amount you owe and divide it by the number of months in your 0% APR promo period. Then pay that amount monthly to completely pay off your balance while you are borrowing without interest. For example, if you buy a $300 TV using a credit card with 0% APR for six months, making $50 monthly payments will eliminate your debt before the no-interest period expires.
Using a 0% intro APR credit card can be a good strategy to pay off your debt or finance a large purchase, but it can be risky, too. While disciplined borrowers can effectively roll balances into new accounts with 0% intro APR, Nitzche says that many people who transfer their credit card balances only make minimum payments, which can result in spiraling debt and damaged credit, leading to a point when they can no longer get approval for new accounts.
Canceling your credit cards
Even if you have paid down your balance on a credit card, there are two big reasons why you shouldn't cancel your account. Closing your account would affect your length of credit history and credit utilization ratio, two important components of your credit score. (Remember, your credit utilization ratio is the percentage of your total available credit lines across all cards you're using.)
If you close an account you're not using, your total available credit line shrinks, making your credit utilization ratio higher.
Canceling older credit cards will also shorten your credit history, leading to a significant drop in your credit score. If you do decide to cancel some of your credit cards, it's best to leave the oldest account open, as well as the one with the highest credit limit to maintain your credit utilization ratio and prevent any damage to your credit score.
It's important to note that with inactivity, credit card issuers may automatically close your account. To avoid this, Nitzche says that it's best to use each of your credit cards once in a while for small purchases.
Applying for too many credit cards
You may have heard this advice before: Don't apply for too many credit cards at once. Each time you apply for a new credit card, your credit score can drop slightly due to a "hard" credit check.
Hard credit checks require your consent and involve a full credit summary from a credit bureau. "Soft" credit checks occur when you view your credit report or a financial company requests a summary without your consent, and they don't affect your credit score. They're used for purposes such as preapproved credit card offers.
When you authorize lenders to pull your credit history, you'll see a "hard" inquiry on your credit report. According to credit score company MyFICO, a hard pull will lower your credit score by about 5 points. While it will stay on your report for two years, the deduction to your score will usually be eliminated within a year.
Too many hard pulls on your credit in a short amount of time -- for example, applying for five store credit cards in one weekend -- could affect your credit rating more, as multiple inquiries indicate higher risks of insolvency or bankruptcy. Experian suggests waiting at least six months between applying for new lines of credit to avoid lowering your credit score.
Applying for too many credit cards at once can drop your credit score.
Sarah Tew/CNET
Not checking your billing statements regularly
How often do you check your monthly billing statement? It can be an eye opener to see how much money you really charge your credit card, especially if it's routinely more than you bring home each month.
Spending $20 here and there may not seem like a huge amount, but it can add up quickly. Remember that increasing your credit utilization ratio (your percentage of credit used) will lower your credit score and high balances will cost you more in interest. Plus, how do you know how much you've charged if you aren't tracking your spending?
Tracking your credit card spending isn't the only reason to check your billing statement. You should thoroughly comb through your transactions to make sure there aren't any potentially fraudulent charges you didn't make. The sooner you discover you're a victim of identity fraud, the sooner you can contact your card issuer to dispute the charges and take the necessary steps to secure your credit card account.
For more tips on using credit cards wisely, learn six ways to get the most from your credit card and how to pick the right credit card.
