Credit Cards 101: How to Use Them Responsibly
The responsible use of credit cards can be a huge contributor to a successful financial footing.
While a debit card or cash works fine for many purchases, there are some cases where not having a credit card can cause a major problem.
Some examples of this would be renting a car or a hotel room.
How you use your credit cards, whether good or bad, is a major contributing factor to your credit score.
Your credit score determines your ability to be able to access better interest rates on future credit cards, car loans, mortgages and more.
How Credit Cards Work
Technically, a credit card account is a revolving credit line that allows borrowers to
At its simplest, a credit card is simply an automated form of an IOU sticky note.
When you swipe your credit card at a retail point of sale or enter your card information online, the merchant’s computer system talks to your credit card company.
The credit card company then checks your account.
If you have enough money under your credit limit, they authorize the merchant to allow the purchase.
Then at the end of the day, the merchant sends the transaction amount to the credit card company, and it posts to your credit card account.
End of billing cycle
Each billing cycle (a month's time), the credit card company will sum up the total of all purchases you made with your card.
That information is sent to you on your monthly credit card statement.
If you pay the full statement balance by the statement due date, then you are not charged any interest or additional fees.
If you pay less than the full balance due, then you are charged interest on the amount that you did not pay.
If you don’t make the minimum payment by the statement due date, then you will also be charged a late payment fee.
How Credit Card Issuers Profit From You
Lenders have several ways to make money from credit cards.
Interchange fees are fees that credit card companies charge to merchants in order for them to be able to accept credit cards.
Since being able to accept credit cards is an important part of many merchants’ business, they willingly pay these fees.
Every time you swipe, the merchant has to pay a fee to accept your card. (Some merchants try to pass that cost onto you.)
When you don't pay your account balance in full, credit card companies will charge interest on the balance.
When you pay interest, you are paying more effectively for your purchases.
High credit card interest rates can keep you in debt for years.
Credit cards themselves can have plenty of fees involved.
Typically, potential card fees include:
While it is possible for the rewards on a credit card to be more valuable than the annual fee, there are plenty of cards with no annual fee.
If you are starting out or looking for your first credit card, it makes sense to look for one of these no annual fee cards.
The other card transaction fees are not common.
How to Apply for a Credit Card
Before you apply for a credit card, it’s a good idea to check your credit report first.
Knowing your credit score will help determine what types of credit cards to apply for.
Depending on the credit card, there is a range of credit scores that will likely be successful applicants.
If you have poor or no credit, you wouldn’t want to apply for a card that requires excellent credit.
Your credit score is just a number, but knowing all of what is on your credit report is also helpful.
Your credit report may include inaccurate information, and cleaning that information up will help raise your credit score. Your income is also very important when applying for a new credit card.
Credit card companies are looking for a financial profile of someone who they think is likely to be able to pay their bills each month. If your income is lower, then you will likely be given a lower credit limit or not approved.
Relationship with Your Credit
Your credit report shows many different kinds of credit activity.
In addition to credit cards, it may show your payments on car loans, student loans, mortgages and other forms of revolving accounts.
Each month, your credit card company will report the amount of credit that you used in relation to your total credit limit.
They will also report whether you paid your bill on time or late.
This information is aggregated and compiled into one number that is commonly referred to as your overall credit score.
Using credit cards responsibly can improve your credit score and that will help you qualify for bigger loans in the future.
Rewards and Perks
Many credit cards come with rewards or perks when you use it.
Credit card companies know that there are many different credit cards out there. So they want to incentivize you to use their card as much as possible. That way they make money through the interchange fees that we talked about earlier.
Rewards and perks vary with each different credit card.
Some common examples would be cash back, airline miles, free hotel nights or other travel rewards.
You will want to make sure that the perks that come with the card are actually useful to you, based on your existing travel and spending habits.
This is especially true if the card comes with an annual fee — make sure that the value of the benefits that you get outweigh the cost of the card’s fee.
Introductory Offers/Welcome Bonuses
Another thing that you’ll want to look out for when considering a new credit card to get is the welcome bonus that comes with the card.
Again, credit card companies know that competition is fierce — so they incentivize you to get their card and spend with them.
Some cards offer an introductory 0% APR interest rate for a fixed period of time.
In some cases this 0% promotional rate is just for new purchases, while in other cases it also applies to balances transferred from other cards. They do this to try and convince you to ditch your old card and use their card instead.
Another popular welcome bonus comes in the form of points or cash back for meeting a specific spending threshold.
For example, a premium travel rewards credit card may offer 60,000 points after spending $4,000 in the first three months of having the card. These welcome bonuses can be quite lucrative, especially as compared to the rewards that you would get from everyday spending on other cards.
Depending on how you use credit cards and what you want out of credit cards, the best credit card for you will vary.
At the very core, you're using a credit line for spending.
You can use it to build good credit.
You can use it to earn rewards.
You can use it as a backup payment form.
Whatever a credit card means to you, ensure that you know how to use it properly to avoid being trapped in debt.