In the right hands, a credit card can be a powerful tool for your financial future. But, use your credit card the wrong way, and you could be up to your neck in debt, and you might even start developing some real resentment toward your mailman for dropping off that bill every month.
Don’t beef with your mailman, just keep reading this article and learn everything you need to know about credit cards, and how to stay out of that deep, dark pit of debt. I’m going to explain exactly how credit cards work, and then I’m going to tell you how you can use them to your advantage.
This is Credit Cards 101! Everything you beginners need to know about that little piece of plastic! Let’s go!
The Basics
You ever meet some wealthy executive, and suddenly he pulls out his credit card and it’s made of metal! You can’t tell me that’s not cool. But, before you can ever get on that guy’s level, we’ve got to go over the basics.
First things first, every credit card is tied to a credit account at a bank and every purchase you make with that credit card gets charged to that credit account. If you didn’t know that, I sure hope you haven’t bought any flat screens with your new credit card yet. Basically, every time you use your credit card, you’re borrowing money from the bank. It’s kind of like getting a mini-loan.
And, just like any loan, your credit account has an interest rate. What’s that? You have a $5,000 balance on your credit card right now? Well, go pay it off! You see, the interest rate on your credit is called your “annual percentage rate” or “APR.” Let’s say your APR is 20%. If you leave that $5,000 balance just sitting there for a year, that means it’s going to grow by 20% to $6,000 by the end of the year. That’s a whole $1,000 that’s coming off your pocket that you could’ve avoided! Luckily, you can avoid paying any interest at all by paying off your full balance. So, always pay off your full balance!
However, that example isn’t all that accurate if you’re a first-time credit card user because all credit cards have a limit, which means that you can only spend so much money on credit before you start getting overdraft fees. If your limit is $2,500 (which is common for a lot of first credit cards), and you spend $5,000 or even $2,501 on credit without paying it down at all, your bank is going to slap you with an extra charge. If you keep continually overcharging, the bank may lower your limit, increase your rate, or even close your account.
So, you have your credit limit and your credit balance, right? What’s the difference between those two? Well, that’s called your “available credit.” Makes sense, right? It’s how much you have available to spend right now without exceeding your limit. Always stay within your limit, consistently pay off your entire balance to avoid that interest charge, and you basically know everything you need to be a responsible credit card user! Good for you!
Now, I know I may have just made credit cards seems scary, and they can be scary if you have no idea what you’re doing. As I said, they can put you under a mountain of debt if you’re not careful. But, if you use your credit card responsibly, you’ll have a sky-high credit score, and that can be a serious asset later in life…
Get a Good Credit Score
If you’re confused as to what a credit score even is, check this out. Your credit score is a number between 300 and 850 that basically lets people know if you’re responsible with credit or irresponsible. Potential lenders look at this number when considering lending you any amount of money, so having a good one is, well, good. But, having a bad one is… you get the point.
No one fully understands all of the factors that go into your credit score, except for maybe the mystery men at Equifax, TransUnion, and Experian, the big three agencies that rate people’s credit scores. But, for the most part, your score is based on your number of open accounts, your total level of debt, and your repayment history.
So, why is it good to have a high credit score? Well, remember that APR, that interest rate that you pay on your credit balance? If you have a good credit score, you’re going to get a lower APR on any credit cards you apply for in the future! And, if you apply for a personal loan, for a mortgage, an auto loan, a business loan, or for anything, you’re going to get a better interest rate on that too!
Plus, a good credit score will help you get approved for a new credit card or a loan in the first place! With a bad credit score, that banker might just kick you out the door. Your credit score affects how much you can borrow as well. That means higher limits on your card and potential for bigger loans from the bank.
But, that’s not all! Your credit score can affect your ability to rent a house or apartment. That swanky pad in Upper West Side Manhattan? You’d better have a good score. It can also affect the car insurance rates you pay, your cell phone plan, and the security deposits you pay for utilities like gas and electricity.
So, since your credit score is so important, how do you make sure you get a good one? The first and most important rule is to only buy what you can afford. People get themselves into trouble by using credit cards to spend money that they don’t have. Always have an idea of how much money is in your other bank accounts, and always make sure you have enough to pay off your credit balance.
The next rule is the 30% rule. Yes, I know that I said that you have to stay below your limit, but if you really want a good credit score, you should stay well below your limit. Always staying under 30% is the best way to do it. That means if your limit is $2,500, keep that balance below $750. Always!
The best practice is to always pay off your balance in full. You spent the money, now suck it up and pay off your balance. Don’t leave it sitting there and let it collect interest.
The last good habit to get into is to check your bank statements and make sure that all of your purchases were actually made by you. Unfortunately, people have ways of getting your credit card info and spending your money! If it looks like that’s going on, tell your bank immediately! Aside from the fact that no one likes getting money stolen from them, fraudulent charges can actually affect your credit score. Plus, getting in the habit of checking your statements will naturally make you aware of how much you’re spending on certain things in a month, and may help you budget your money better.
Follow all of these tips and you’ll never have to worry about getting in debt or having a bad credit score. Then you can walk into the bank with your chest puffed out and get that mortgage loan for that mansion you’re going to be living in!
So, now that you know everything about using a credit card, you’re ready to go out and get your first one. But, which one should you go with?
The Ideal First Credit Card
If you want to have a solid credit score, you really want to have as much credit history as possible, and that means that the first credit card you get will ideally stay with you for your entire life. So, first off, get a card with no annual fees. Some credit cards make you pay every year to keep them open, and if you’re paying that over your whole life, it’s going to add up. Get one with no annual fees.
Some credit cards also offer free FICO score trackers, which means that you can check your credit score whenever you want. You definitely want this feature so you can keep an eye on your score and make sure it’s on the up-and-up. But, try not to check your score too much, because your score can actually drop if the credit rating companies think you’re overly worried.
Next, look out for credit cards with large security deposits. Sometimes credit card companies will try to make you pay a deposit of couple hundred dollars to open a credit card. Don’t do that. If you look hard enough, you should be able to find a company that charges you nothing to open your account.
Finally, look at those rewards! I’m talking about cash-back, which means that you get a percentage of your spending back, or rewards points, which are basically just money that can be spent at certain places. If you absolutely love Olive Garden, get a card that has rewards points at Olive Garden. Unlimited breadsticks every night of the week, baby!
The other option is airline miles. If you’re a big traveler, that’s probably your best option. You could get a weekend flight to Cancun just by using your card! Finding the right rewards is all about finding the right plan for your lifestyle.
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