Do you need to spread the costs of a major purchase? Or want to build your credit history? There’s no better way than opening a credit card account. A credit card can offer a flexible and secure way to pay for major purchases in installments. That being said, you need to be aware of the pitfalls associated with different types of credit cards to avoid costly financial mistakes.
Keep reading for our simple credit card guide, which we created to teach you credit cards 101. From how to get a credit card to how do credit cards work, we’ll answer all your basic questions and then some. Armed with this foundational financial knowledge, you’ll be in a better place to use credit cards to your advantage in 2020.
How Credit Cards Work
Let’s start with a fundamental question. How do credit cards work? Think of credit cards like taking out a loan. The card allows you to spend up to a pre-set limit. This limit might be a few hundred or a few thousand dollars. How is your limit determined? By the amount of income that you bring in and the credit card company’s confidence in your ability to pay back the loan. In exchange for loaning you this money, credit card companies charge you interest each month based on your current balance.
In other words, if you pay off the card in full each month, then you can avoid paying interest fees. Of course, if you don’t pay it off in full, you’ll start accruing those fees. These can add up, particularly if you’re only able to meet your minimum payments each month, so you should work hard to avoid this cycle. Another important thing to know about how credit cards work is how interest is calculated. Since interest charges often get backdated, expect to pay a whole month’s interest each time you fail to pay off your balance.
The credit card rules prove different when it comes to cash withdrawals and checks. Credit card companies start charging you interest (of up to four percent or more) from the time that you withdraw cash funds, so expect a higher interest rate than for regular purchases. So when you receive those convenient checks in the mail from a credit card company, beware. They don’t come with the same protections that credit card purchases do, and they can prove more expensive to use.
The Difference Between Credit Cards and Debit Cards
Although debit cards offer some conveniences similar to credit cards, they function differently. Debit cards let you make purchases from your checking account without having to write checks or carry cash. Debit cards do this by placing holds on the money in your checking account based on your purchases. These transactions then get sent to your bank, initiating a transfer to the merchant’s account. This transfer could take up to a few days to process.
Debit cards also require the use of a personal identification number (PIN) rather than a signature. That being said, if you need to make a debit purchase and can’t use your PIN, you can sign the receipt as you would a credit card purchase.
Unlike credit cards, you won’t pay interest on debit purchases, and they don’t impact your credit history. Since the money you make purchases with has an immediate hold placed on it, you also avoid the risk of overspending. However, this means when your checking account is empty, your buying power with a debit card evaporates unless you have overdraft protection. Expect to pay high daily fees when you overdraft a checking account too.
When it comes to the difference between credit cards and debit cards, keep in mind your long-term goals. When used properly, credit cards represent a fantastic way to build a solid credit history and improve your credit score, but debit cards can’t deliver on either of these fronts. Therefore, when you know how credit cards work, they can be a great addition to your spending habits.
Types of Credit Cards
Credit cards come in an assortment of types, including:
- Balance transfer credit cards
- Student credit cards
- Rewards credit cards
- Charge cards
- Secured credit cards
- Business credit cards
- Prepaid credit cards
- And even more…
Many people stick with standard credit cards. These are sometimes referred to as “plain-vanilla” credit cards. Why? Because they don’t come with the bells or whistles other credit cards do, such as cash back rewards or airline miles. If you’re after the frills, go for a rewards credit card.
Balance transfer cards refer to cards that offer a low introductory rate on balance transfers. They’re great for saving money when it comes to credit card balances with high-interest rates.
Student credit cards are for college students who would like to start building credit histories. Many come with perks, such as low-interest rates or rewards, to attract students who are just learning credit cards 101.
Charge cards don’t have spending limits, but balances must be paid in full each month. Late payments for these cards are subject to fees or cancellation depending on the terms of your agreement.
For people who have a poor credit history, secured credit cards offer a solution. They require a deposit or security placed on the card in advance. Prepaid credit cards necessitate loading money onto the card in advance to cover purchases.
Finally, business credit cards are designed solely for business use. They permit entrepreneurs to distinguish between business and personal spending with ease. Before you start using a business credit card, make sure you know how to responsibly use credit cards for your business, or you could be setting yourself up for bankruptcy.
How to Get a Credit Card?
Once you fill out a credit card application, the lender will conduct a credit assessment to check your credit reference file. If the company determines you’ve got a decent credit score, this will improve your chances of getting the credit card. It will also give you access to lower interest rates.
Before applying for any credit cards, note that you should be 18 years or older. Some credit card companies prove even more rigid when it comes to age, refusing to offer credit cards to individuals under the age of 21.
You should also bear in mind that you’ll need to make the minimum payment each month. This requirement goes for interest-free periods, too. Make sure your budget is prepared for this, so you don’t overspend and then realize you can’t even make the minimum payment on your credit card. If you’re sure you can afford a minimum payment each month, then you can set up an auto-debit each month to pay off your credit card. Make sure you payment is as much as you possibly can afford each month, to avoid amassing an ever-growing debt and interest percentage.
Worst case scenario: what happens if you miss a payment or two? It will negatively impact your credit score. A poor credit score, in turn, limits your ability to seek loans with low-interest rates and can influence every financial decision you make in the future. This is why you need to take getting a credit card seriously, and make sure you know what you’re getting into so you never get behind on your payments or create an insurmountable amount of debt. Learning credit cards 101 is your first step to using your credit to your financial advantage.