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When Is An Annual Fee Credit Card Worth it?

Annual fees on credit cards often seem unnecessary. After all, there are so many cards out there that offer good rewards and no fee. Why should you pay for the right to spend money?

So are there any situations in which getting (or keeping) a card with an annual fee makes sense?

Here are five scenarios where it can be worthwhile to pay for an annual fee:

When it comes with a much-needed 0-percent interest rate

If you already have substantial credit card debt, a 0 percent interest rate offer on a new or existing credit card can help you pay down or pay off that debt. This is especially true if your current credit card debt carries a double-digit interest rate. For example, if you are currently paying 13.99 percent on a $10,000 credit card balance, a 0 percent interest rate offer could save you nearly $1,400 over the next 12 months.

Of course there are limitations when it comes to 0 percent interest rate offers. One is that the 0 percent offer is only good for a limited amount of time-generally between six months and 18 months. Once the initial offer ends, regular interest rates will apply, and they may even be higher than the rates you are paying on your current credit card balances.

You also have to take balance transfer fees into consideration. Many cards with 0 percent interest rate offers charge between 3 and 5 percent of the amount of the balance transfer. This will virtually eliminate the benefit of the 0 percent introductory offer if it only lasts for six months or so. But it may be worth paying if the introductory offer extends over the first 15 to 18 months after the balance transfer.

Most credit card companies that offer 0 percent interest rate offers also waive the annual fee for either the first 12 months, or for the length of time that the introductory rate applies.

Since there will be no annual fee charged during the introductory phase, the card may be well worth taking even if an annual fee will apply later on. You could even consider canceling the card once the introductory phase ends. But in order to do that, you should make sure that the balance on the card has been paid in full.

That said, there are also a fair number of cards offering generous 0 percent introductory periods that don’t charge an annual fee. Best to look to them before committing to a card that does.

When canceling the card will hurt your credit score

You probably already know that canceling a credit card can hurt your credit score. That’s because it increases your credit utilization ratio. Your credit utilization ratio is the amount you owe on all of your credit cards, divided by the total credit available to you on all your cards (i.e. all your credit limits added up).

For example, if you have total credit limits of $25,000 on all of your credit cards, and you owe $10,000 on them, your credit utilization ratio is 40 percent ($10,000 divided by $25,000). A good credit utilization ratio is considered to be 30 percent or less. The more you exceed this ratio, the more it will hurt your credit score. That matters, because your credit utilization ratio accounts for 30 percent of your total credit score, making it the second most important factor in calculating your score, after paying your debts on time (which is 35 percent of the calculation).

Using the example above, if you have total credit limits of $25,000, and you cancel a credit card that has a $10,000 credit limit, your available credit drops to $15,000. That will increase your credit utilization ratio to 66.7 percent ($10,000 divided by $15,000). That’s a high ratio, and it will drop your credit score almost overnight.

That being the case, you may not want to cancel a credit card in order to eliminate the annual fee. You can think of the fee as a small price to pay to maintain a higher credit score. That’s worth doing because it can translate into lower interest rates, and better offers in the future.

As an alternative, if you have a credit card that has an annual fee, and you want to get rid of it, do so only after obtaining a replacement credit card with a comparable credit limit, and no annual fee. Learn more about getting rid of an annual fee without hurting your credit.

When the benefits of the card more than offset the annual fee

Certain credit cards provide you with substantial financial benefits, even though they come with an annual fee. Many provide supplemental rental car insurance that can save you a small fortune each time you rent a car. A single car rental situation can more than offset the annual fee charged by the card.

Some cards also offer benefits that work based on your lifestyle and spending patterns. For example, the Chase Sapphire Preferred Card offers substantial benefits to travelers. You can earn 50,000 bonus points after spending $4,000 on purchases within the first three months of opening the card. They waive the annual fee for the first year, and then charge $95 per year thereafter. But the bonus points are good for up to $625 in travel expenses.

If you know that you are going to spend at least $4,000 in the first three months, and you travel frequently and will have a need for the bonus travel rewards, the card will be worth having despite the $95 annual fee. If you aren’t sure of any of that, then it’s best to hold off.

When you actually use those benefits regularly

Many credit cards offer valuable benefits to their cardholders. But those benefits only matter if you will actually use them. If you are in the habit of accumulating credit cards based on bonus and rewards offers, but you never actually use them, having such cards makes little sense, particularly if you have to pay an annual fee to keep the card.

Before accepting any credit card offer, make sure that the bonuses and rewards they provide are consistent with your spending habits. Also make sure that they will not put you in a position to spend extra money in order to qualify for them. As we found earlier this year, most rewards cards (even those with an annual fee!) give out roughly the same amount in rewards for average spending.

For example, with the Chase Sapphire Preferred Card discussed above, it’s an excellent offer if you would normally spend $4,000 anyway. But if you have to go on an unplanned spending spree in order to qualify for the rewards, it’s probably not worth the effort.

And sometimes, increased rewards aren’t worth it. For instance, the American Express Blue Cash Preferred offers double the rewards on groceries compared to its no-fee sibling, the Blue Cash Everyday. But, with average spending, and the annual fee factored in, the Preferred only yielded less than $20 in overall annual rewards.

In addition, if you reach a point in your life where you are no longer using the benefits, you should probably want to cancel the card if it comes with an annual fee. There is no sense paying a charge for a card that provides no tangible benefit.

When you can’t qualify for a no-fee card

The best deals on credit cards are generally reserved for those who have good or excellent credit. But if your credit falls somewhere below, it may not be possible to get a no fee credit card.

If that is the situation, you may have to accept a credit card that charges an annual fee. That’s not an entirely bad situation, however. If you use the card responsibly, and make your payments faithfully each month, having the card can help to improve your credit score. In addition, you will need to keep the credit utilization on the low side-certainly no more than 30 percent-to help your credit score.

If you can manage both strategies comfortably, then the card will be a benefit to you despite the fact that you have to pay an annual fee. Once your credit score begins to improve, you’ll be in a better position to apply for credit cards that have better offers, including those that do not require that you pay an annual fee.

Summary

In an ideal world, you’d never need to pay for an annual fee on a credit card. But under the right circumstances, it may be worth having the card even with the fee.