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.
(Remember when you were a kid and it was really exciting to get a piece of mail? Credit card companies have killed that joy.)
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In the simplest terms: a debit card is linked to your bank account so money is automatically withdrawn when you swipe.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.
Image from Pexels
The day after I turned 18, my mom put me on the phone with a credit card company to get my first card. (I don’t know why I had to call… maybe it was my lack of financial history or co-signer.) Anyway, she told me I needed to begin my credit history right away and it was one of the greatest gifts she’s ever given me.
In college, i remember that credit companies would have all sorts or gags to get students to sign up like free swag + a burrito if you just signed up for a card. “You still get this free t-shirt even if you’re not approved.” Avoid avoid avoid! My tip would be to go for a Visa or Mastercard as the first card because if you ever find yourself in a bad situation, pretty much everyone accepts these brands.
Going with Visa or MasterCard is a good tip. I might snag that for my next post in this series. I remember when I signed up for a bank account near my school I got a free backpack and thought that was pretty awesome. Lord only knows what could’ve happened if I got offered a free t-shirt for a credit card!
This is a great post! My sister is just beginning to really learn about credit cards, and I definitely will have her read this.
Thanks, Michelle. I’m planning to do a series with it so if you have any questions you think I should address let me know!
I had a similar experience. My mom told me once I turned 18 that I should get a credit card to start forming my credit history. I never saw my parents use credit cards irresponsibly (they did that behind the scenes!) and they warned me about the dangers of debt. I didn’t really need the warning since I saw what happened firsthand. Unfortunately I guess my mom believed the myth that having a balance helps your credit score, so I kept small ones for a few months. I’ll never do that again!
At least you know now not to keep the minimum balance. I had never heard that until I started doing research for this post!
i think you should emphasise getting debit cards instead of credit cards, because if u are going to pay off the credit cards every month,(and that is crucial, you must pay it off in full ) there is no advantage to having credit cards as oppose to debit cards, other than the 1month grace period that u get before u get billed by the credit card. also if u are going for credit cards, get one that have no annual fee, nevermind what the APR is. if u are going to pay the full amount it is not important what the APR is. forget about those rewards, you have to spend a lot of money to get them, and that will tempt u to spend more than you can afford to pay off in full every month.
I disagree, I think it’s important to have a credit card but to use it responsibly. Credit cards help establish credit and can be used in a bind for an immediate access to funds (which you need to be able to pay off before the billing statement). APR is important for people to understand so they’re motivated to pay off their bills on time. It is important to look for no annual fee cards, as mentioned in the post.
I’m OK paying an annual fee on my credit cards as long as I’m getting a benefit at least as great as the annual fee plus whatever I could get on a credit card without the fee. Some of the best reward cards do have an annual fee, so you need a certain level of spending in order to make it worth it.
I’ve had my credit card for six years and never cashed in on rewards. Mostly I’m just letting them rack up for something awesome. The idea of rewards isn’t enough for me to pay an annual fee, but I guess you’d need an awesome reward incentive.
It is very important to learn about credit cards, credit score, credit reports and history right from young age as it helps a lot. I definitely plan to teach kids when they grow
I couldn’t agree more.
I am curious how you personally use your CC now? Do you still just keep it for small things/emergencies? Do you only use it for the rewards?
I can address that in the next post! I just use it a few times a month to keep it active and keep my credit score healthy (well 10% of my score healthy). It’s nice to have for emergencies, booking travel and the occasional online shopping. I think it’s better to buy things online with a CC because it’s easier to refute a charge than with a debit card. Rewards aren’t a big incentive for me.
Very nice overview Erin! Sadly, too many of these basics are all too lost on many people.
Hopefully that can change soon!
Hey Erin! Thanks for this awesome post!!! It did clear up some questions that I have. I have both, a credit and a debit card. I love using my debit card and try not to use my credit card, but unfortunately had to use it for car emergencies. Unfortunately, it stays maxed out because I am horrible about budgeting. I don’t open any store credit cards just because I know there’s a bad temptation. I work at a department store and it ALWAYS pressures me to open a charge and I know it would be bad.
Anyways, thanks for this great post!
Store credit cards make me nervous too and are certainly going to get addressed in the next post!
Great primer on credit cards Erin! When I was first in college I understood some of these things. However, I worked for a bank selling college credit cards to clueless college students, and I saw a lot of them make HUGE mistakes with them. In fact, I see my blog as part reparation for that. 🙂
Thanks, Nick. I’m sure you could share some scary stories about kids with credit cards. I sense a good post…
Great explanation, Erin. I don’t consider credit cards to be bad and can be wonderful tools. We just have a tendency to abuse their privilege in large part because so few people understand how they truly work and the dangers of carrying a large balance. Sadly college students who should rightfully establish a good solid credit history are easy targets because too many view credit cards as a license to spend (and in all fairness far too many adults feel the same way).
Thanks, Shannon! I agree, credits cards aren’t bad. People are sometimes just misinformed and end up with debt that could have been avoided.
I don’t fully understand the latest credit card law that was passed recently but I think folks under 21 can no longer get a credit card unless they have proof of income or a cosigner which is good way to stop unemployed college students from getting into debt before they understand the ramifications of credit cards and carrying a balance.
Also, many folks don’t know that you can “opt-out” of all of those pre-screened offers. If you call a 1-800 number that is detailed on the offer letter, it will enable you to stop receiving them in the mail.
Thanks for the tip about the 1-800 number, I better track that down! I think it’s could primarily be a good move to require kids under 21 to at least show proof of income in order to get a credit card. I’ll need to brush up on that law as well. At least it will keep credit card lenders off college campuses during the first week back/freshman days.
I always worry that my kids won’t understand money because they always see me pay for everything with a credit card. I do it for convenience and rewards….but they don’t know that. They will probably just look back and remember that I charged everything!!!
It’s the way the world is moving though. How many people are really, consistently paying with cash these days? Most are at least using debit cards. I’m pretty much the only one in my social circle who travels with more than $20 on my person. I think you’ll do a great job of teaching your kids financial literacy so they’ll just know how to use the cards responsibly!
Education is key here. I wasn’t taught about credit or credit cards and learned the hard way in college when I signed up to get a stupid shirt and a cup. Still remember that day like it was yesterday. I grew up only seeing my parents using cash. I don’t really like using credit cards and mostly use my debit card. I agree pay your balance in full every month if you can. Its crazy that these companies don’t just tell us what we need to do to increase credit scores. Some say leave a balance others its 1/4 of the balance and then pay it off in full. Who knows just dont depend on your credit cards to live is my thought.
You shouldn’t leave any balance on to increase the credit score, paying it off in full each month is what helps you.
Credit cards really shouldn’t be used to exceed money you already have access to by the time you’re paying the bill. I’ve even heard of people using them to pay loans off. Breaks my heart!
Great explanation! Credit card debt is so easy to get into. One unexpected expense here, one splurge there, a couple months of paying the minimum…next thing you know you have a huge balance to pay. I hope that through education efforts and opportunities to make extra money while going to school (and after school!) will help bring down the overall debt in the future.
Thanks, DC. I’ve managed to avoid ever needing to pay the minimum. The father of a friend of mine told his son it’s perfectly acceptable to only pay the minimum each month. No wonder kids get into such trouble!
Great article, I love your blog’s concept. My experience was similar–got a Visa freshman year of college to build credit. I didn’t know that you shouldn’t carry a balance though, I guess that must be a commonly believed mth! Luckily, I have a crushing fear of debt so I never put more than gas and groceries on it, and pay the bill each month.
If anyone would like to check out my new blog, I’d be so grateful!
http://greenmountainglobetrotter.blogspot.com/
I hate credit cards…The only card I have been using is my debit card. I have some credit card debt which I got from buying things I wanted rather than needed. Right now I do not see any need of a CC.
I started off with a share credit card when I turned 18. I felt safer getting my first credit card this way since it allowed me to lock a portion of my savings (only about $500). Like you mentioned, I also only used mine for gas and paid it off every month just to start establishing credit history and this did wonders for me! I didn’t feel as intimidated when switching to a regular credit card and I have a great credit score now because I started establishing it early. The only downside to the share credit card is that since it’s my longest line of credit I don’t want to close it out and have it affect my credit score, so that money does stay locked in my savings. Which luckily I kept it a small amount :).