Credit Cards: No Need to Fear
How does a credit card work?
If you’re starting from ground zero and are looking to build your credit score, opening a credit card is one of the easiest ways to get started. However, misusing your credit card can negatively impact both your credit score and your financial health.
Understanding how credit cards work is imperative to making your credit card your best friend and not your frenemy.
A credit card offers the flexibility to borrow money to pay for items and then pay the money back later. Each month you receive a statement with total owed based on how much money you borrowed and any additional fees.
If you don’t pay the balance in full before the due date on your statement, interest charges will begin accumulating. Make sure that you stay up to date on what interest rate your credit card is currently charging and how that rate can fluctuate. Additionally, there are often charges for late payments and for exceeding the credit limit on the card. Make sure that you review the disclosures that you receive with your card so that you are aware of all of the potential fees and how to avoid them.
The best practice to follow when using a credit card is to spend as if you were paying with cash. Don't buy anything you can't afford to pay off in full at the end of the month. This will help you avoid interest or late fees.
Learning the Terminology:
Annual Percentage Rate (APR): The yearly rate of interest you pay on borrowed money.
Credit Limit: The limit set on how much they will allow you to charge to your credit card each month. A few factors contribute to determining your limit, such as credit score, income level, etc. Over time, your credit limit can increase if you follow best practices.
Credit vs Cash
If you’re wondering when the best time is to pay with credit as opposed to paying with cash, it ultimately depends on a few different factors.
Depending on where you’re shopping, some vendors charge a convenience fee or require a minimum amount for paying with credit card. If you don't want to pay extra fees you may opt to pay with cash under this scenario. If you have a rewards card, you may choose to use a credit card for most purchases to earn cash back. Depending on your rewards card benefits you may also accumulate travel rewards to put towards your next vacation.
What if you have an emergency like a necessary car repair? We recommend reading our previous article on emergency funds. Having a separate savings account dedicated specifically for the unexpected is the best way to tackle this scenario. Let's face it, we will all encounter more than one unexpected expense in our lifetime and being prepared is the best way to cushion the financial impact. Your credit card shouldn't be your emergency plan.
Ultimately, a credit card is a great device to build and maintain good credit. Depending on what card you get, you can benefit from great perks, but mishandling your credit card is detrimental. Remember, a credit card is not a tool to enable you to go over your budget. Pay off your balance diligently and monitor your spending habits.
