As a freshman in college my first financial decision was to get a credit card. I can sense you financially savvy readers wince. Usually, credit cards and college freshman are about as compatible as the cast of Jersey Shore and afternoon tea at The Waldorf Astoria. Even so, my Dad insisted I have a credit card because my parents lived over 8,000 miles away in a foreign country. He also wanted me to begin establishing a line of credit, albeit a paltry one.
As an expat child in Japan and then China I’d grown up in cash-based societies. I didn’t even see my parents swipe plastic too frequently. The feeling of money in my hand, or leaving my wallet, helped me understand the ramifications of a purchase. The swipe of my debit or credit card made it far to easy to overspend before pay day. For the first two years of college I only would purchase gas with my credit card. The idea of getting hooked on the swipe (that’s what we call it on the streets) was too intimidating.
Unfortunately, far too many of my fellow millennials have found themselves in consumer debt due to credit cards. The use of credit and debit cards can be a dangerous game to play with your bank account. Overspending is an obvious source of the consumer debt problem. However, some people are just misinformed or not sure about the rules of credit cards, especially because banks and lenders love to make it easy for you to obtain a credit card.
What’s the difference between debit cards and credit cards?
In the simplest terms: a debit card is linked to your bank account so money is automatically withdrawn when you swipe. Credit cards aren’t linked to your account so you have to pay a bill each month.
The money you use with a credit card belongs to the card issuer’s and you have to pay them back on a monthly billing cycle. A credit card is useful if you need to make an expensive purchase and don’t have all the money in your bank account at the moment. However, you should only make a large purchase you know you can pay off by the end of the billing cycle.
Why should you pay off your bill in full each month?
Credit cards can lead to massive amounts of debt because each month your lender will allow you to make a “minimum payment.” I view this as a “we’ll get off your back for now” payment and bank’s love it because now they get to charge you interest.
Someone, probably a credit lender, started a nasty rumor that keeping a monthly balance on your credit card will help your credit score because it shows responsibility by continuing to make payments on time. FALSE! All it equals is paying more interest. Continuing to pay the minimum instead of paying off the full bill could also make your lender view you as high risk and result in your interest rate going up.
As long as you keep your card active by making a few purchases a month and then paying your bill in full you are helping your credit score.
Understanding the basics of APR
When you apply for a credit card you’ll see a section referring to APR or annual percentage rate.
What is exactly does that mean? The APR is how your lender will calculate the interest you are charged if you don’t pay your monthly bill in full.
(My current credit card is 8.9%….)
APR = Periodic Rate x Number of Periods in a Year
For example: You have accumulated $800 worth of outstanding charges on your credit card. If your APR is 15% then you would have $120 of interest in a year. Well, it could be more and that’s assuming you make no other charges. By having a minimum payment you’re essentially incurring outstanding charges each month on your bill that you’ll pay interest on.
You can also be charged at a variable rate that changes throughout the year, so be sure to clarify your rate when opening a credit card. You should also consider how a lender is charging you interest.
Side note: The difference between APR and APY is compound interest. APY accounts for compound interest while APR does not.
Why does my credit card cost me an annual fee?
To make money of course!
Not all banks/credit lenders charge an annual fee, so be sure to shop around and try to find the lowest APR rate and a card with no annual fee.
Don’t be afraid to negotiate. If you have an annual fee try talking to your bank or lender about waiving or reducing the fee.
(Be sure to look for annual fees as well as penalties for late payments. Apologies this caption wasn’t witty.)
What is a credit limit?
Your credit limit is the amount of money your card issuer is willing to loan you per month. For example, if your credit limit is $2,000 then you can’t charge more than $2,000 in a month on that card without maxing it out and incurring penalties.
How do you get a credit card?
The easiest way is through your bank. However, that may not be the best credit card option. Various banks and lenders will offer different APR rates, annual fees and credit limits. If you’re anything like me, you will be constantly bombarded with mail offers to open a credit card.
(Frankly, it’s easier to get a credit card than to get decent candy on Halloween.)
Do you have a credit card horror story? What are your tips for using credit cards? Feel free to add in more questions for me to address in next week’s post.