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Why do some credit cards charge an annual fee?
When you’re looking to take out a credit card, you might see that some charge what is called an “annual fee”, which can cost anywhere from around £25 to over £100 per year. But, what exactly are you getting by paying this fee?
A cost for rewards
Generally, most credit cards that charge an annual fee will do so because they offer lucrative incentives such as cashback, rewards points or 0% interest periods.
The rewards offered on this type of credit card are often much more enticing than those offered by credit cards that don’t charge an annual fee. However, you’ll have to weigh up whether the rewards outweigh the annual fee before you jump the gun and take one out.
Just when you’ll have to pay your annual fee will vary from card to card. Some credit cards will require you to pay one lump sum every year, whereas others may charge you a set amount each month.
Is it worth it?
Whether or not paying for an annual fee is worth it will depend completely on your spending habits. Before you take out a credit card with an annual fee, it’s worthwhile doing some calculations to see if the rewards would be worth more than you will pay each year in fees.
For example, some credit cards may offer 5% cashback on all purchases, while charging an annual fee of £120. In this case, you would have to spend at least £2,400 every year to earn back what you pay for the annual fee – providing you clear your balance in full each month.
To find out how much you usually spend, have a look through your annual credit card bills for previous years, and see whether it’s above the level where you will start to see benefits.
For example, you may find that you spend around £2,500 each year. Here, a credit card offering just 1% cashback with no annual fee would be a better option. With the 5% cashback and annual fee, you would make £5 profit in a year, whereas with just 1% cashback and no annual fee, you would earn £25 extra per year.
The same goes for credit cards that offer other rewards such as store points or interest-free periods. You will have to judge each card independently to see whether the rewards outweigh the cost of the annual fee. If you use a balance transfer credit card with an interest-free period, see if the interest you are paying on your current credit card balance is higher than the annual fee you will pay on the new one.
But, like with any credit card, it’s important to stick to the terms of the agreement. You’ll want to make at least the minimum repayment each month and stay within your agreed credit limit, otherwise you risk facing charges, damage to your credit history and losing the rewards incentives. And, as you’ll still be charged interest on your spending each month, you have to be careful in order to avoid paying more in interest than you save in cashback. That’s why it’s recommended you clear your balance in full each month to make the most from these types of credit card.