When I was around 22 years old, I got my first credit card. It was also my last credit card for about a ten-year period after I cancelled it. You see, like many young people (or even just financially inexperienced people, regardless of their age), I got into some trouble with my credit and it scared me off of cards for many years after.
Thankfully, I didn’t even get into real serious trouble– but it was scary, all the same. I had bought a computer and put it on my new card, not really understanding how the card worked (so I found out), and by the time my first monthly payment came along (which was a higher amount than I could afford), my parents were quickly bailing me out of my trouble and I was swearing off of credit cards forever. Now, I had thought I understood how my shiny new card worked at the time– but it turned out that I very clearly didn’t. So this post is all about the things I wish I had known about credit cards before I ever got one.
Here’s the first thing that everyone should know about credit cards, and I’ve said this before: credit cards are, in general, a good thing. Responsible use of a credit card builds your credit in a positive way, and good credit has lots of value and benefits. Credit cards are not evil. (They’re just little, flat pieces of plastic. They’re inanimate. In order to be “evil,” they would have to be capable of some level of moral judgment. 😛 ) If you were to tell me that you think that credit cards are evil, I would try to convince you that it likely means you just don’t know enough about them and/or aren’t using them correctly.
Let’s start with the absolute basics, assuming that you don’t ever want your credit to go kerflooey. Credit cards have two primary characteristics: 1) Limit; and 2) APR.
Point 1: The card’s limit is obviously the maximum amount of money that you can borrow off of the card. If you’re a credit card beginner, that idea is an important one– you are borrowing that money, which implies that you need to pay it back. I’ve talked about this before, too: having a credit card is the same thing as having an ongoing loan. Your credit card shouldn’t be looked at as a free pass to spend, spend, spend. Of course, you can certainly choose to do things that way– but that choice has consequences (and sometimes dire ones, at that.)
I have a couple more thoughts on limits. Generally speaking, if you are brand-new to credit (or if you have poor credit and are trying to repair it), your credit card limits are going to be low. Most “starter” cards have limits around $300-500. Again, if you’re using it properly, that limit shouldn’t matter too much; but if you’re using it irresponsibly, having a low limit means you can’t get yourself into nearly as much trouble. So, that’s a good thing. However, having a low limit also means you need to be a little more careful about not damaging your credit score by carrying too high of a debt percentage, which is obviously a bad thing. You want your credit cards to improve your credit rating– not destroy it.
An easy way to avoid that trouble is by paying the card off or down before your statement even gets printed and sent to you. Most credit cards have online tools to check your balance up to the minute and you can often make electronic payments in real time. The benefit of paying off the card before your statement comes out is that when the credit card companies report to the credit bureaus each month, they report what the statement said. So if your card was maxed out at the time that your statement got processed, even if you paid it off after that, your credit report would look like it was still maxed out. There’s no disadvantage to paying off the card periodically throughout the month, so give that some thought.
Point 2: APR means annual percentage rate. How the actual interest on your card generates is pretty complicated (you might already recognize that link from the recent post on compound interest) but APR is meant to suggest what you could expect to pay on the card over the course of a year, though the numbers may not work out exactly like that because of the prorated way that interest is calculated and applied. The most important thing to know about interest is that you are only charged interest if you carry a balance into the next billing cycle.
In fact, in case I lost you there, let’s back up and talk about the billing cycle. The billing cycle is, in the simplest of explanations, the period of time between billing statements. Your credit card statement tells you your due date for your payment. Your billing cycle starts from that point until the time your statement next gets processed/printed and sent to you. So, what that means is that if your credit card is paid down to a zero balance as of your payment due date, you don’t owe any interest on the card.
But let’s assume that you can’t pay off the card at the end of the month, for whatever reason. When I was 22 and I bought my computer, my intent was to use the card as a long-term loan. (Back in those days, credit card APRs were super low. If I remember right, I think it was only 4-5% APR on my card.) So I bought the computer, considered the card a low-interest loan, and was going to pay it back month by month (which actually isn’t the worst mentality, in and of itself. At least I had a plan, despite the plan being seriously flawed…) But I didn’t understand how minimum payments were calculated (in addition to not understanding how interest really worked, either.)
Minimum payments are all calculated a little differently by each creditor but you can read the fine print on your credit card application or statement to figure out how exactly your card provider figures it out. When I was 22, I (incorrectly) thought that APR determined my monthly payment– and the makeshift math I did to figure out what I could expect my regular monthly payment to be turned out to be way off base. What I thought would be a $50 a month payment turned out to be $150, which I couldn’t afford. I didn’t just not do the necessary research going in; I was also a victim of my own lack of knowledge, in the first place. Trial and error unfortunately requires error. (If only I’d had a great financial education blog I could have been reading at the time…)
Speaking of minimum payments, the Credit CARD Act of 2009 changed some regulation of the credit card industry. Among many other changes, since 2009, on monthly statements, card issuers need to display how long it would take to pay off the existing balance – and the total interest cost – if you only made the minimum payment. Statements also have to display the payment amount and total interest cost to pay off your existing balance in 36 months. At least in terms of your credit card, consumers are better informed today than ever before. As always, you are responsible for making smart financial choices, but at least there’s some more information out there to help you do so.
A few last things that should be touched on briefly are annual fees and rewards programs. Generally, if you have poor credit, you’re going to find that you qualify for lots of cards that have annual fees and few, if any, that have rewards programs. Rewards programs are fantastic. Annual fees are not. As a general rule, I usually encourage people to avoid getting a card that has an annual fee (which I assume doesn’t need explaining but, just in case, an annual fee is a yearly fee that you have to pay in order to use the card. It’s crazy to me– you are charged a fee to use a card that the creditor is going to make interest off of. It’s a double whammy.) Also, as a general rule, I strongly encourage people to get a rewards card, if they’re able. If you have a card that gives you money back on gas and groceries, for example, then you should put all your gas and groceries on it (and then make sure to pay it all off, of course.) It’s free money. Take it. 😉 As you build credit (or improve it) you’ll find more and more opportunities for good rewards programs (NCCYou has a great one, in fact.) Find one that you like and start taking advantage of the good credit benefits you’ve earned for yourself.
Those are some credit card basics. Do you have any questions about any of this? If so, contact me and I’ll do my best to get those questions answered and get you off on the right foot toward being a healthy, responsible credit user.