Credit cards can be your friend or foe. They promise perks like cash back, airline points, and the benefit of building credit for buying a car or home. But they can also get you in financial trouble. Americans currently carry $1 trillion in credit card debt, which is the highest it has ever been.
Many people find it hard to resist buying things they can’t afford, which is where debt trouble starts. Educating yourself about credit, however, is the best way to be a savvy consumer who uses credit cards wisely. Here are the five things you need to know about credit cards:
1. How Do Credit Cards Work?
Credit cards are like borrowed money. A credit card has a limit that you can spend before the card is shut down. The card issuer, which could be a company like Chase, Bank of America or Citibank, extends an unsecured loan to you for one month. Unsecured means there is no collateral for extending this credit to you.
You receive a statement each month that shows how much you borrowed against that limit. You have one month to pay it back before interest accrues according to the annual percentage rate (APR) that came with the card. You’ll usually have a minimum payment that can be as low as 1% of the balance. As long as you make the minimum payment, you won’t receive a “late” ding on your credit report; however, it isn’t wise to carry a balance, because interest can accrue quickly.
2. Should I Carry a Small Balance?
It’s not advisable to carry a balance on your credit cards. The main reason being that you’ll be charged interest, which increases the cost of whatever you purchased. Let’s say you bought a sweater for $100. If you only pay the $10 minimum payment and carry the $90 to the next month, you will be charged $11.70 in interest if you have an APR at the U.S. average of 13%. Now, that sweater costs you $111.70.
The benefit to using credit cards is to build your credit, but you can do so by paying off the full balance each month. The rule of thumb is to borrow no more than 30% of your credit limit and to pay it off in full and on time, every time.
3. What Happens When I Apply for a Credit Card?
When you apply for a credit card, you get a “hard inquiry” on your credit score. This means that a third-party looks at your score to see if you meet their standards. This hard inquiry results in a negative hit to your score.
Applying for multiple credit lines in a short period of time can decrease your score further. However, multiple inquiries for what’s known as installment debt such as student loans, auto loans, and mortgages within a short period of time are bundled as one inquiry because you’re expected to compare different offers for these loans.
Furthermore, getting approved for all of the credit that you applied for will count negatively against your score, because of the “new credit” and “length of credit history” categories. Don’t open a credit card when you’re shopping for an auto loan or a mortgage, because you need to give your score time to recover from these hard inquiries.
4. What is a Credit Score? Why Does it Matter?
In the U.S., credit scores are based on your credit files and a statistical analysis that will generate a number showing your creditworthiness. That’s a long way of saying you’re being scored on your likelihood to pay your bills.
Information from the three credit bureaus Experian, TransUnion, and Equifax is aggregated to show your score. The benefits of keeping a good credit score include being able to have great interest rates on mortgages, auto loans, and personal loans. Landlords may also take a look at your credit score to determine if you’re an eligible tenant. Employers have increasingly started looking at credit reports before hiring a candidate, which has risen from 19% in 1996 to 42% in 2006.
Americans are entitled to one free credit report per year from the three bureaus, but this doesn’t include a credit score. You can go to a site like CreditKarma.com and access your credit score at any time. Don’t like what you see? Some ways to improve your credit score include:
- Checking for inaccuracies in your credit report. Make sure there are no erroneous late payments. Check that the amounts owed are accurate, too.
- Set up automatic payments for your credit cards. It’s common for people to forget to make credit card payments, but this can cause your score to drop. Set up automatic payments for the highest amount you can pay. If it’s the full balance, that’s even better. Just make sure it’s more than the minimum payment.
- Focus on reducing your debt. Create a payment plan and a budget so you can reduce the amount of debt you owe.
5.What is a Balance Transfer?
Transferring your balance from one credit card to another has the benefit of giving you 0% interest for a fixed period of time. These cards usually offer 12, 18 or 24-month periods to pay off the debt. Balance transfers are a great tool to get out of debt because no interest accrues while you make the payments.
The caveat is that applying for a balance transfer card will cause a hard inquiry on your credit score. Some cards also charge a fee for transferring your balance, which effectively adds to the total amount due. Missing a payment can also invalidate the 0% interest offer and you may end up paying way more than you planned. Be sure to read the terms and conditions carefully to know what you’re getting into.
Recommended Credit Cards for Students
Many students are in a position that they don’t currently have credit but would like to build it responsibly. Here are some recommended credit cards for students:
No Credit Check: Good for People with 0 Credit
- $35 annual fee
- 39% APR
- No credit check necessary to apply
- The refundable deposit you provide becomes your credit line limit on your Visa card
0% Intro APR: Save Money on Interest for the First Year
- No annual fee
- 0% APR for the first 12 months, 13.99% – 23.99% after that
- $150 cash rewards bonus after making at least $500 in purchase(s) within the first 90 days of account opening
- Earn 1% cash back on purchases, 2% cash back at grocery stores and wholesale clubs and 3% cash back on gas for the first $2,500 in combined grocery store, wholesale club, and gas purchases each quarter
Bonus Rewards: Earn Rewards for Purchases
- No annual fee
- 0% APR for 6 months for purchases; 10.99% for 6 months for transfer balances
- Regular APR 13.99% – 22.99%
- Get a dollar-for-dollar match of all the cash back you’ve earned at the end of your first year
- Earn 5% cash back at places like gas stations, grocery stores, restaurants, Amazon.com, or wholesale clubs
- Good Grades Rewards: $20 cash back each school year your GPA is 3.0 or higher for up to the next 5 years
Bonus Points: Earn Rewards Points for Dining and Entertainment Purchases
- No annual fee
- 0% intro APR for purchases for 7 months; 15.74% – 25.74% APR after 7 months.
- Earn 2,500 bonus points after spending $500 on purchases within the first 3 months of account opening
- 2,500 ThankYou® Points are redeemable for $25 in gift cards, electronics, and other great rewards when redeemed at thankyou.com
- Earn 2X Points for Dining Out & Entertainment Earn 1X Points on All Other Purchases
Using credit cards wisely means practicing good habits with your spending. Pay attention to your credit report and credit score and diligently pay off your balance in full each month. Avoid giving in to temptation by only using your credit card for things you can afford to pay cash for. Following these tips will help you to take control of your finances and establish good credit in no time.