Are you completely new to the world of credit cards? Interest rates. Cash back bonuses. Credit limits. It can all be quite confusing! This quick credit card guide will get you started in understanding all the credit card basics:
Credit Card Pros and Cons
As with all other financial products, credit cards have their pros and cons. And they’re not necessarily the best choice for everyone. Here are some of the things to consider before you decide to get a credit card:
- They build credit history. Credit cards, particularly easy-to-get secured credit cards, are a great way to build credit history. You can certainly live without credit cards, but without credit history, you won’t be able to get more important loans for things like a car or a home.
- They can act as a safety net. If you don’t have an emergency fund or are just starting to build yours, a credit card can be a decent safety net in the meantime.
- They offer fraud and purchase protection. You’re legally protected from paying for fraudulent credit card purchases made in your name. But the protection doesn’t end there. Many cards offer warranties or purchase protections, and some also offer travel and rental car insurance (as long as you purchase the guaranteed/insured items with your card, of course).
- They may offer great rewards. Some credit cards offer great cash-back or point-building rewards that can really save you money on things you use every day.
- You can use them to buy now and pay later. The whole point of a credit card is that you can buy something now and pay for it later. Used wisely, this is a great way to juggle monthly finances or to buy big-ticket items without saving up to a long time first.
- They charge high interest rates. Credit cards have some of the highest interest rates of any loans around. If you don’t pay off your balance in full each month, you could get stuck paying a lot of extra money on basic purchases.
- The minimum payments won’t get you far. Credit card minimum payments are actually designed to keep you in debt – and paying interest – as long as possible. You’ll have to pay more than the minimums if you want to get out of debt.
- They may charge other high fees. Credit card fees are pretty much at the discretion of their respective companies, so you may get charged extra interest or outrageous fees for balance transfers, cash withdrawals, late payments, and more.
- Credit cards let you spend more irresponsibly. When you have credit available, it’s tempting to make irresponsible purchases, which can cost you dearly in the long run.
Essential Credit Card Terminology
Before you can choose a credit card that works for you, you’ve got to understand the basic terminology. Understanding what a credit card issuer means when it says “APR” or “annual fee” will give you a better grasp on credit card basics:
- Annual fee: Many credit cards come with a once-a-year fee to own the credit card. Some cards have no annual fees, but, often times, those with the best rewards or interest rates do have fees.
- Annual Percentage Rate (APR): This is the annual interest charged on outstanding credit card balances.
- Introductory rate: Many cards charge a lower interest rate for the first few months that you own the card. Be sure you know how long the introductory rate will last, and what the APR will be after that introductory period.
- Balance: This is the amount of money that you owe on your credit purchases.
- Credit line/limit: This is the maximum amount you can charge to a specific credit card account. (Some cards won’t allow you to charge more than your credit line, and others will just charge you extra fees if you go over the limit.)
- Available credit: This is the difference between your credit card balance and your credit limit. (ie. If your limit is $3,000 and your balance is $2,000, your available credit is $1,000.)
- Minimum payment: This is the minimum amount you’ll have to pay on your credit card to keep the account in good standing. Due to recent legislation, your credit card statement will show you how long it would take to pay off the balance making only minimum payments.
- Overdraft protection: Some banks let you link a checking account to your credit card, so if you bounce a check from your checking account, the excess will be charged to your credit card. This can shield you from overdraft penalties and bounced checks.
How Credit Card Interest Works
One of the most important things to understand about credit cards is exactly how interest works. If you don’t pay off your credit card balance every month, you may end up paying a huge amount of interest over time. Interest is charged every month, and it will just keep adding up.
Here’s an example of how credit card interest works:
Let’s say you make a large purchase and charge $3,000 on a card with an 18% interest rate. Making minimum payments of interest plus 1% of your balance, it will take you 222 months (18.5 years!) to pay off your balance. In that time, you’ll pay $3,923 in interest – more than doubling the original charge.
As you can see, credit card interest can really work against you, even if you make slightly more than minimum payments.
The Basics of Choosing a Credit Card
Choosing a credit card is all about figuring out 1) what credit card companies might offer you and 2) what works best for you.
The first – what credit card companies may offer you – is largely based on your credit history. If you have bad credit or no credit history, you’re not likely to get a premium card with a low interest rate and killer perks. If you’re just starting out, you may even need to look into prepaid cards.
Deciding what works best for you has a lot to do with what you’re going to use the card for.
If you want to make a balance transfer, check out cards with a 0% balance transfer offer. If you’re going to use the card for a major purchase that you’ll pay off over time, check out cards with lower interest rates. If you’re planning to use the card for everyday purchases, pay it back in full each month, and reap the rewards, a travel rewards card or cash back card may be for you.
The key is to compare credit card offers and interest rates to ensure that you’re getting the best card for your particular financial situation. Many people even keep multiple cards that they use for different types of purchases in order to maximize savings and rewards.
Do’s and Don’ts When Using a Credit Card
A credit card can be a financial tool or a financial trap, depending on how you use it. Here are some do’s and don’ts to help you use your credit card wisely:
- Do stick to a budget, even when using a credit card. If you’re tempted to live beyond your means by constantly swiping your card, leave it at home.
- Do plan to make more than minimum payments, even on large purchases. Remember how that interest adds up!
- Do consider using a card for set expenses that you’ll pay off every month. Paying electric, gas, internet, cable, etc. with a credit card helps ensure you don’t over-spend, since these are all necessary expenses, but lets you reap credit card rewards, at the same time.
- Do take your time when choosing a credit card, and compare offers to ensure you’re getting the best deal.
- Do negotiate for a lower interest rate after you’ve proven yourself to be a good customer.
- Do let your lender know as soon as possible if you won’t be able to make a minimum payment. Many will work with you to come up with an affordable payment plan.
- Don’t carry a large balance on your credit card, as this will lower your credit score.
- Don’t forget to check your credit card statement each and every month.
How to Read a Credit Card Statement
The government has recently made credit card companies create easier-to-read statements, which can help you, as a consumer, make better credit decisions. Learning to read this statement can help you make the best possible choices.
The Federal Reserve offers a detailed example of a credit card statement. This is a great example to check out because it shows what should be on a credit card statement, and about where everything will be located on your statement.