Credit cards can be great when used right. However, if you use them wrong, you can hurt your credit score and damage your chances of securing credit in the future.
Here’s everything you must know about credit cards and how they work.
How Credit Cards Work
A credit card is a credit line extended to you for use, with the promise that you’ll pay back what you borrow.
With your credit line comes a grace period, usually 25 – 28 days. During this grace period, you don’t owe anything, but by the due date, you must make at least the minimum payment, if not pay the entire balance.
It’s best to pay your full balance each month to improve your credit score and show responsible use of your credit line to future creditors and the credit bureaus.
Consider these Factors Before Opening a Credit Card
Before opening a credit card, it’s important to understand the responsibility that comes with it. When a credit card company gives you a credit line, they do so because they trust that you’ll repay the balance.
If you don’t repay it, and the balance remains unpaid for 3+ months, the credit card company will likely send your balance to a collection agency that will try to get it from you either themselves or with a lawsuit.
Ideally, you shouldn’t charge more than 30% of your credit line, so it doesn’t hurt your credit. 30% of your credit score is your credit utilization, or how much of your balance you have outstanding. Having more than 30% of your credit line outstanding can negatively affect your credit score.
Pros and Cons of Having a Credit Card
If you’re ready for a credit card, here are the pros and cons to consider.
Pros:
- They are secure – Credit cards provide more security than cash. For example, if you lose your credit card, you can freeze the card and dispute any charges you didn’t make. But if you lose cash, you can’t get it back. Credit card companies also protect your large purchases. For example, if you didn’t receive the item, or it was defective, you could dispute the charge, and if the credit card company agrees with your dispute, you won’t be charged.
- They help you build credit – If you use credit cards responsibly, they can help you build a solid credit score. For example, your payment history is the largest part of your score, so if you make your payments on time, you’ll build a stronger score.
- You might earn rewards – If you have great credit, you might qualify for a rewards credit card. These cards pay you cashback or points for your purchases. You can redeem the rewards for statement credits, gift cards, or money toward airline tickets.
Cons:
- They have high-interest rates – Credit cards have much higher interest rates than most consumer loans. You might pay 19 – 25% daily compounded interest on any balances you carry after the grace period. Interest accrues every day the balance is outstanding, so it’s best to pay your full balance before the due date.
- It’s easy to overspend – If you get a high credit line, it’s easy to spend money you wouldn’t normally spend. It’s not like cash; you can see and know how much you have. If your spending gets out of control, it could cost you a lot of money in interest charges and hurt your credit.
- It can hurt your credit score – If you don’t use your credit card responsibly, you could hurt your credit score. For example, one payment made more than 30 days late or going over your credit limit once can cause your score to drop.
The Different Types of Credit Cards
There are different types of credit cards to consider, each with different benefits.
- Secured credit cards – These cards are best for consumers with no credit history or a bad score. Your credit line is the same as your deposit, and the credit card company keeps your deposit if you don’t make your payments.
- Store credit cards – Stores typically offer a branded credit card for use at their store only. These cards are great for beginners and usually have low credit limits.
- Cash back credit cards – Cards like Discover offer cash back on certain purchases. Some cards have revolving categories that pay cash back, and others pay a flat percentage on all purchases.
- Rewards credit cards – Rewards credit cards also pay cash back, but they offer it in different ways, such as airline tickets, hotel stays, or gift cards.
- Black credit cards – These cards are exclusively for the wealthy with great credit. They offer many more perks, such as airport lounge access, concierge programs, and high cash back percentages.
What Should you Consider Before Opening a Credit Card?
When you’re looking for a credit card, consider the following:
- Is there an annual fee? Some cards are free, and others charge a fee for their card. Don’t pay an annual fee unless the rewards you’ll earn greatly outweigh the cost of the card.
- APR – Credit cards have high-interest rates, but some come with an introductory rate on purchases and transfers. In addition, some cards have lower APRs overall than others. Shop for the card with the lowest interest rate if you carry a balance.
- Know what you need – Consider why you’re opening a credit card. Are you trying to build credit, earn rewards, or save money on interest? There are many types of credit cards, so knowing what you need will help you choose the right card.
Final Thoughts
Credit cards are a great addition to your financial life if you use them right. Only apply for credit cards when you benefit from them, such as earning cash back rewards or if you need to build credit.
Use your credit cards responsibly, and don’t charge something just because you can. Instead, try paying the balance in full immediately, and a credit card can help you build better credit and be eligible for even more rewarding cards in the future.
