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Introduction to Credit Cards
A credit card allows you to borrow interest-free money interest-free under the condition that you pay it back on time. But they’re more than just payment solutions for goods and services.
With responsible credit card use, you can save money, improve your credit score (trustworthiness to financial institutions), and even earn rewards for shopping.
On the other hand, improper credit card use will harm your credit score, potentially cost you your fortune, and cause financial ruin.
Fortunately, you can reap all the rewards with no downsides if you can follow these credit card essentials. Learn how you can choose the right card, properly/safely use credit, make payments, get out of credit card debt, and more.
Signing Up for A Credit Card
Even among credit cards, there are many differences that make each one unique. Understanding which credit card(s) work best for your situation is just as important as how you use it.
Selecting the best credit cards to sign up for and understanding how they work is the first step to improving your credit and optimizing your finances. Use these criteria to determine which credit card is right for you.
Promotions
Some cards may offer promotional sign-up or spending bonuses to attract new customers. These bonuses can include cash, airline miles, redeemable points, or other rewards.
Promotions often have spending requirements and/or a time limit. To qualify for the reward, you may have to spend a few thousand dollars within a several month period.
Yet people manage to take advantage of these offers through credit card churning, or repeatedly signing up for new card offers. Once they receive the reward, they cancel the card before any applicable fees kick in, or they keep it to maintain a high credit limit
Rewards Card
Some companies reward you for using their credit cards because they charge the merchant (not you) a payment processing fee. Incentives to swipe your card include cashback or redeemable points.
If you receive cashback, you can deduct it from your credit card bill or make your money work for you, such as investing in the stock market.
Meanwhile, you can exchange redeemable points for electronics, gift cards, or convert them to airline miles for your next vacation. Just note that exchange rates aren’t equal across all rewards.
While you can get more value out of certain rewards (10,000 points for $100 worth of airline miles vs. a $50 gift card), you should only choose rewards that you’ll use. So, if you hate traveling, don’t waste your points on airline miles simply because they may give you the most bang for your buck.
Credit Card Fees
Some credit cards have an annual fee, which may reduce the value you get from rewards/cashback. Luckily, there are plenty of no-fee alternatives.
Even so, some credit card benefits justify the fee. Perhaps your card offers greater buyer protection features or greater cashback.
Suppose you can only decide between a 4% cashback card with a $100 annual fee and a 2% cashback card with no fee. To justify paying the fee on the higher cashback card, your 4% cashback – $100 fee must earn more than the 2% card.
You can calculate the amount you have to spend on the 4% card to earn more than the 2% card:
0.04x – $100 fee = 0.02x
0.04x = 0.02x + $100
0.02x = $100
x = $5000
For the 4% card to outperform the 2% card, you would have to spend $5000 or more a year. You would earn $200 cashback and pay the $100 fee, for a total of $100 cashback. Spending the same amount on the 2% card yields $100 cashback without a fee.
Interest Rate (APR)
A credit card’s interest rate, or APR (annualized percentage rate), tells you how much the company will charge you for making late payments.
After you receive your monthly credit card statement, you have several weeks to make interest-free payments. Interest rates only apply to an unpaid balance after this deadline.
You don’t have to worry about interest if you pay off your full credit card balance on time. But if you anticipate making late payments for any reason (which isn’t recommended), choose a card with the lowest APR.
APR varies depending on your credit score. With a higher credit score, you can enjoy a lower interest rate that usually helps insure against risk of non-payment.
However, some credit card companies may even offer an introductory 0% APR to attract new customers. Even so, you should still responsibly use your credit card to avoid slipping up once the introductory period is over.
Hard inquiry
When you sign up for a credit card, the company will perform a “hard inquiry” to check your credit. Each time there’s a hard inquiry into your credit, your credit score drops a little.
The greater number of hard inquiries you have, the more likely you’re seeking a lot of credit. And with higher credit, comes higher risk (in the eyes of financial institutions).
Someone who needs a lot of money immediately is at risk of being unable to pay it back, which may drop their credit score by a little. This is only temporary, as the hard inquiries disappear from your credit report after 24 months, if they even make a dent at all.
Even so, you can increase your credit limit and suffer a lower short-term credit score, but enjoy a higher credit limit and lower utilization rate, which ultimately increases your credit score in the long-term.
Credit Card Purchases
Although credit cards allow you to temporarily spend more cash than you have on hand, many people overspend and are unable to pay it back. Therefore, you should only buy what you can afford. Otherwise, you risk financial ruin via high interest rates and debt.
If you must spend a lot of money for a large purchase you can’t pay back, there are other loans with lower interest than a credit card’s APR.
Cashback and Rewards
When you use your card for certain goods and services, you may earn cash back or rewards. Always try to pay with the card that earns you the highest rate of return for that purchase.
Each card has its own rates, product/purchase categories, and reward limits, such as:
- 2% cashback on restaurants and groceries, up to $2000
- 4% cashback when shopping at a certain retailer (e.g., Costco, Target)
- 2 points for each $1 spent
These numbers are illustrative purposes only.
Although it feels like you’re getting a reward every time you pay with your credit card, remember that you’re getting a small incentive, not free stuff. Don’t let the rewards mentality trick you into overspending.
Not only can doing so deplete your savings, but high interest rates (if you can’t afford to make a payment) will outweigh any rewards you gain from the purchase.
Purchase Alerts
You should always sign up for notifications whenever there are new charges on your card. These alerts will alert you to any fraudulent charges, allowing you to call your bank to file a dispute (more on this later).
Credit Limit
Your credit limit is the most you can spend in a billing cycle (usually a month) before your card issuer requires payment. So, if you max out your $5000 credit card limit, you can no longer use that card in that billing cycle unless you make a payment.
Credit limits increase with your ability to pay (income) and your financial trustworthiness (credit score). A high credit limit benefits you because it lowers your credit utilization ratio, which, in turn, improves your credit score.
To illustrate credit utilization ratio, suppose credit card user A has a $10,000 credit limit and user B maxes out their credit at $2000. If they each spend $1,000, A has spent 10% of their total credit limit ($1,000 out of $10,000) while B has spent 50% of theirs ($1,000 out of $2,000).
Expense Type
Some credit card companies categorize your purchases (transportation, groceries, electronics, etc.) to help you manage your expenses. This is extremely helpful if you want to figure out whether you’re meeting your monthly budget goals or what you’re overspending on.
Credit Card Payments
Statement Accuracy
At the end of each billing cycle, you’ll receive an itemized statement of your purchases for that period. Afterwards, the card issuer gives you a deadline to pay back the balance.
Ensure that all purchases are legitimate and accurate. If you’ve set up alerts for purchases, the notifications should match up with the statement amount. However, your alerts don’t apply any tips you give after the initial payment
Late Payments
Always make timely payments in full! Not only will missing a payment negatively affect your credit score, but the company may issue a late fee or charge interest on an unpaid balance. The compounding interest on a credit card balance can cause financial ruin.
If you ever miss a payment, ask your credit card company if they can waive the late fee and interest if you pay it back immediately. Your card issuer may let you off the hook if you usually make payments on-time. They want to retain a good customer, so punishing you for a small mistake is poor business practice.
Auto-Pay
Setting up auto-pay ensures that you’ll never miss a payment (if your linked account has sufficient funding). Set up auto-pay by linking it to your checking/savings account and then ensure a well-maintained balance. Otherwise, you may have to deal with overdraft fees due to insufficient funds.
If you happen to have an overdraft fee and are otherwise a good customer, you can also ask to waive the overdraft fee. Like with late payments, your card issuer may let you off the hook to keep you as a customer.
Credit Card Security Features/Benefits
Credit cards offer you much more protections than a debit card usually would. Debit cards practically grant a merchant direct access to your bank account. Unless you pay at the register every single time, a middleman (waiter) may end up writing down your information before charging your card.
Although not uniform across all credit cards, a credit card is more likely to have these features than a debit card.
Fraud Protection and Chargebacks
The Fair Credit Billing Act protects consumers from unauthorized charges greater than $50 on a lost or stolen credit card. While this means you can pay up to $50 for a fraudulent charge, some credit card issuers won’t hold you liable for unauthorized charges.
Make sure to only use this chargeback feature on truly fraudulent charges, or you’ll be stealing from legitimate businesses!
Purchase Protection
Some cards offer you purchase protection, which ensures that you get what you paid for. Although terms may vary across card issuers and different cards, they typically protect you from lost, stolen, damaged, or defective items. This coverage may even last for a few months of your purchase date.
Price Protection
If you purchase an item and find it for cheaper elsewhere within a specified period, your card issuer will credit you the difference.
However, certain purchases will not qualify for price protection or price guarantee. There may also be reimbursement limits per item and per year. Make sure to read the conditions for this special card benefit.
Extended warranty
Credit card companies sometimes match the original manufacturer’s warranty. For example, they may add a 2-year extended warranty on a 2-year manufacturer warranty, effectively doubling it.
The company may also limit warranty coverage to a certain cash value per item, and an annual claim limit per account.
Virtual cards
Some credit cards offer temporary virtual account numbers so you can shop without giving merchants your actual credit card number. You can disable the virtual account number once you make the purchase to avoid getting your data stolen in a data breach or through an insecure/public internet connection.
Card Freezes and Replacement
If you have a lost or stolen credit card, you should immediately place a freeze on the card (sometimes through an app) and report it to your card issuer. The freeze will lock the card from additional spending until you get ahold of customer service to cancel the card number.
You’ll receive a new card in the mail, along with new credit card numbers in case the old numbers were compromised. That means you’ll need to update payment information on recurring services to continue receiving them.
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