A credit card is a plastic form of payment that lets you make everyday purchases without carrying cash. But while these cards seem easy to use, you can get into debt and damage your credit without knowing the basics. With a solid financial foundation in place, you’ll be better prepared to use a credit card responsibly.
Analyze Your Spending to Avoid Going Into Debt
Unlike a debit card purchase, where the money comes out of your checking account, a credit card works like a loan. When you use it, the card issuer lends you the money for the purchase with the agreement that you'll repay it.
Not seeing money come out of your account makes it easy to spend more than you earn. If, as a result, you can't pay your balance in full by the due date, you'll incur interest charges on your balance. If you don't pay at least your minimum balance by the payment due date, you might also get hit with late-payment fees. Likewise, if you exceed your available credit limit, you could incur over-the-limit fees.
The amount you pay in interest depends on the interest rate, expressed as an annual percentage rate (APY). Assume that your credit card has an APR of 15.1%—the average interest rate for cards for current accounts as of February 2020. That figure rises to 20.2% for new accounts. Carry an average balance of $6,190 on that card for one year, and you'll pay a whopping $935 in interest. As your balance balloons to an amount you can't repay, you might default on payments or go deep into debt, both of which can hurt your credit score.
To avoid debt, total your income and expenses in a typical month and set a budget. This monthly spending plan will prevent you from spending more than a set amount on your credit cards, keeping your balances low. Ideally, spend less than you earn each month so you have money left to save for other financial goals.
Usually, you'll have a grace period of 21 to 35 days to repay what you borrow interest-free. If you don't make payment in full within that grace period, you will be charged interest.
Track Your Credit Score
Lenders use your credit score to determine how risky you are as a borrower and decide whether to approve you and at what terms. Before you go credit card hunting, learn your credit score to narrow your options to cards you're likely to be approved for. You can get a free annual copy of your credit report with each of the three major credit bureaus from websites like AnnualCreditReport.com.
The higher your credit score, the less risky you appear to lenders, and the more likely you are to get approved for a credit card with attractive rewards or a low interest rate. The card issuer will usually specify the score range you need to qualify for the card; the best credit cards often require a score of 740 or higher, defined as "very good" to "excellent."
After you get a credit card, monitor your credit score on an ongoing basis; it can go up or down based on your credit card spending behavior. Your payment history, credit in use, length of credit history, new credit, and types of credit can all impact your credit score for better or worse. Maintain a high credit score to improve your prospects of getting new credit cards, a mortgage, or other loans.
Most lenders use the FICO score (ranging from 300 to 850) to determine your credit risk profile.
Understand Borrowing and Paying Back
Whenever you borrow money, know your rights and responsibilities. Importantly, a credit card is a type of “open-end” or revolving loan. This means that you can borrow money continually as long as you abide by the terms. Compare this with a closed-end loan like a car loan, which you can take out only once.
Also, find out the APR on the card, how to determine the amount you owe each month, the grace period, and the payment due date. And know what happens when you don’t fulfill lender expectations—for example, what fees apply if you don’t pay the money back on time.
Practice Good Checking Account Management
Your checking account isn't just the place from where bill payments for your credit card will likely get withdrawn. As the hub of your finances, it dictates your monthly cash flow and serves as a proving ground for managing your credit cards.
Fortunately, the same skills you use for smart checking account management will enable responsible credit card use. For example, monitoring your account balance is a necessary skill for both checking account and credit card management.
You should be able to handle your checking account without overspending before considering a credit card. There are several ways to develop good checking habits:
- Make regular deposits into and withdrawals from your checking account.
- Balance your checkbook.
- Check your account balance before spending.
- Avoid writing a check or making debit card purchases in excess of your balance.
Understand How Credit Card Rewards Work
Some credit cards offer rewards to cardholders as an extra incentive to spend. Known as rewards credit cards, these options come with perks like cash, airline miles, or points you can redeem for services or items.
The rewards you earn are proportionate to what you spend; for example, you might earn one point for every dollar you spend on a credit card. Some issuers offer sign-up bonuses that earn even more attractive rewards if you sign up for the card and spend a certain amount within a certain period.
While it can be tempting to get a card for the initial or ongoing rewards, chasing rewards can lead you to rack up account balances you can't repay. Rewards cards can also come with annual fees that can add to your costs. As you prepare for a credit card, choose one with benefits you can leverage without going into debt.
Know Your Credit Card's Due Date
Each month, your card issuer will track your credit card purchases and issue you a bill with the amount you owe. The monthly billing statement may be the only reminder your card issuer offers that your payment is coming due. Fortunately, your credit card payment will be due on the same day every month, making it easier to manage.
To prepare for a credit card, put in place a system for remembering important dates. If your bank offers it, set up an alert to be reminded before payment is due. Or, use another reliable method, like a calendar app.
- Creating a budget allows you to enjoy the convenience of credit cards without falling into the debt trap.
- Understanding card payment terms and other borrower responsibilities can help you pay on time and avoid unnecessary costs.
- Tracking your credit score and maintaining it can help you pinpoint the right cards for your profile and boost the odds of getting other loans.