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The Get

What is a credit card annual fee? What does it pay for?

Here’s the answer to this week’s reader question.

“Is it true that only good credit cards come with an annual fee? What does an annual fee actually pay for?”

—Janek

Have a question you want answered? Send it to TheGet@neofinancial.com.

What does a credit card annual fee pay for?

When it comes to credit cards with an annual fee, that cost acts like a membership charge that you pay to unlock special perks or rewards. This fee customers pay helps cover the costs of the rewards program and can also be part of a credit card company’s overall revenue. Credit card providers add value to their financial products by offering unique benefits to encourage the use of their credit card over another company’s card.

Annual fees are typically charged right to the card, so budgeting for this cost is essential. Also, not every rewards card comes with an annual fee. Many no-fee credit cards offer reward programs, though earning points may be slower compared to cards with fees. Higher annual fees usually mean higher earn rates, so it’s worth doing a quick calculation to see if the rewards match your spending habits and outweigh the cost to have them.

Before we dig into the math, pause and ask yourself: What rewards matter the most to you and why? Maybe it’s time with your family on vacation, discounts to take the stress off your household budget, or tickets to an event for date night with your partner.

There are three common types of credit card rewards programs: Cashback cards, loyalty rewards (such as Air Miles, Aeroplan, or PC Optimum) and those with points that can be redeemed for merchandise, hotel stays and passes for things like attractions or movies. Certain cards also have additional perks, such as airport lounge access, concierge services or even a comparatively low interest rate. Consider what perks would add value to your current lifestyle and choose your credit cards to support those goals.

Now the math. Start with a simple cost-benefit analysis. Before you sign up for a credit card or cancel one because of the annual fee, calculate whether the rewards will cover at least the annual cost.

Say you pay an annual fee of $125 for a cashback card, and you earn 5% back on purchases made with the card. You would need to spend $2,500 a year to break even. But compare that with a similar card with no annual fee and an earn rate of 2% of that same amount would give you $50 cash back.

But it’s never only about the math—other perks come into play too, so it can help to use the credit card comparison tool from the Financial Consumer Agency of Canada.

Also, take the time to read everything. If we go back to that 5% cash back example, the questions you want to ask are: Is that 5% earned on everything I put on my card or just certain categories like groceries or gas? Do my spending habits align with the requirements to earn those rewards?

Be curious, ask those questions and also review your money habits. Call the credit card company and ask, if you can’t figure it out yourself.

Collecting points can absolutely be worthwhile, but the price might be too steep if you spend more to justify collecting the points. Ultimately, the best credit card to choose is the one you can afford and where you don’t feel pressured to spend just to get enough points or perks to cover the annual fee.

—Sophie Pratt

Director of Creditor Engagement at the Credit Counselling Society

As told to Carli Whitwell

Carli Whitwell is an award-winning Toronto-based lifestyle journalist. She’s written for EE72, Refinery29, ELLE Canada, The Toronto Star and others. Her hobbies include going out for dinner and sleeping in.