You may already know that it’s important to use credit cards responsibly. You also may have heard stories from those who learned that a credit card can be a double-edged sword, a great way to establish and maintain good credit, but sometimes can land cardholders in a world of financial trouble if they aren’t properly managed.
But what if we told you credit cards aren’t as complicated or scary as they seem? We’re here to help by offering best practices for using your card — so that you can stay on of top of your finances and maximize your financial well-being.
What is a Credit Card?
A credit card account gives you access to a line of credit that can be used for most types of purchases. Your line of credit — or your preset borrowing limit — will be dependent on your credit history. The better your credit score, the more likely you’ll be offered a higher line of credit.
You can use a credit card to buy groceries, gas, car insurance, a new washer and dryer, or a hotel stay at your favorite weekend getaway. Now that we are in the midst of the holiday season, you may even want to indulge in a gift for that special someone. (Even if that special someone is yourself.)
When using a credit card, you’re borrowing funds from the financial institution that issued you the card. In other words, you’re using the lender’s money to pay for purchases up front rather than your own. By doing so, you are then obligated to pay off the charges made on your card, either in full or with regular smaller payments that are a portion of your balance by a predetermined due date (usually monthly). If you do not pay the balance in full and opt for the monthly payment option, you’ll be charged interest on the amount borrowed.
Credit Cards Versus Debit Cards
Debit cards are directly linked to your checking account. Every time you purchase goods or services using your debit card, the purchase amount is immediately deducted from your account. Similar to cash, your debit card represents money that you currently have in your checking account.
Debit cards require you to have sufficient funds in your account at the time of purchase, unlike a credit card which allows you to borrow money to make your purchase, even if you don’t have the funds immediately on-hand.
Because you’re borrowing money when using a credit card, the balance you carry each month will impact your credit score. If you carry too high of a balance or do not make timely payments, your credit score may be negatively affected. If you make payments before or by your due date or, better yet, pay off your balance in full each month, your credit score will likely be positively affected.
Credit Card Interest Rate
You may be wondering how the interest accrual works – is it calculated on each purchase you make with your credit card? While this is a common misconception, credit card interest is measured with an annual percentage rate (APR). So instead of accruing interest with each transaction, you only accrue interest on unpaid balances you carry over into the next month.
The Consumer Financial Protection Bureau calls interest “the price you pay for borrowing money.” An important piece of advice when applying for credit card: find out its APR first and then determine whether you can afford to pay back the balance in full, or make the minimum monthly payment (usually around 2% of the card balance). Even if you can afford to make the minimum payment, consider how long it will take to pay off the balance and how feasible this is.
Most credit cards typically come with a higher APR (in comparison to other types of loans). If you’re opening your first credit card account, an even higher APR may apply to you because you may not yet have sufficient credit history to assure lenders you’re a reliable borrower.
If you have a credit card with a high APR, you should make every effort to pay your balance in full every month rather than keeping a running balance. This will help to establish and build your credit.
Finally, be aware that some credit cards have a fixed APR, while others have APRs that are variable. A fixed rate card has the same interest rate for the entirety of the borrowing period, while a variable rate card has an interest rate that can change over time. Also, some card issuers also charge a yearly fee for the use of their credit cards, but not all do. Always thoroughly review your credit card agreement to ensure you fully understand the rates and terms of your card.
Types of Credit Cards
There are many different types of credit cards available with varying rewards and features. The following are some common types of cards in today’s market:
Low-Interest Credit Cards
Low-interest credit cards offer a minimal interest rate to cardholders, which can be helpful carrying a card balance. Some card issuers even offer an introductory 0% APR, so you could have up to a year or more (within the introductory period) to pay off a larger purchase without interest. Be aware, however, that intro rates on cards often increase after the promotional period is over, so be privy to what that interest rate will be.
Balance Transfer Cards
If you already have high-interest debt on one credit card, you may want to consider applying for a balance-transfer card. This will allow you to move the balance you have on your current card to a credit card with a lower interest rate.
Keep in mind that you may be charged a balance transfer fee, and can be limitations for how much debt can be moved to a new card. For this kind of transfer to be useful, look for a 0% or low-rate introductory APR offer, and then aim to gradually pay off the debt before the year is up. Some card issuers will run promotional rates specifically for balance transfers, so keep an eye out and make sure the rate applies to transfers (and not limited to purchases or cash advances).
With this type of card, you earnt ‘rewards’ for each dollar you spend. The type of reward will vary, but they often involve cash back, points, extended warranties, or other incentives that can be redeemed once you’ve earned specific thresholds.
In general, rewards cards tend to have higher APRs, and you will often need to have an above-average credit score to qualify for one. Below are the most common types of rewards cards.
For every purchase you make with a cashback card, a certain percentage of that purchase is returned to the customer as a cash incentive. As a benefit, cash back rewards can be an easy way to make the most of everyday expenses. Typically, cash-back rewards range between 1% and 2%; however, if you take some time to research, you may find some cards in the market that offer even more.
Co-Branded Airline and Hotel Rewards
Co-branded credit cards are issued by a financial institution but connected to a specific airline or hotel chain. Each time you use this type of credit card, you earn points toward free airfare or a hotel stay. This type of card can be beneficial for those that travel frequently. However, the rewards associated with the merchant sometimes come with restrictions and blackout dates, so it’s a good idea to review all of the terms before signing up.
General Travel Rewards
General-purpose travel rewards (in other words, not tied to a specific reward vendor) are more flexible and have fewer restrictions. You can apply your earned points toward expenses like ordering a rental car, dining out, and other travel expenses. The redemption process is usually managed by the card issuer.
Store rewards credit cards can be used to purchase merchandise at one specific retailer or a group of retailers. These credit cards are often referred to as “closed-loop” cards since you can only use them at that particular retailer.
Each time you use the card at the store (either in person or online), you can earn rewards like cash back, points toward merchandise, and discount coupons. Depending on the retailer, you may also be eligible for extra time to return items or free shipping.
“Open-loop” cards allow you to use a store-branded card more broadly, usually at any retailer that accepts Visa or Mastercard. These cards may not offer the exclusive benefits listed above, but if you want to be able to use your card at a wider range of retailers, you may want to consider the open-loop version.
Credit Improvement Cards
If your goal is to improve your credit score or prove that you can responsibly use a credit card, then you’ll want to find a card issuer that tailors to this market. According to NerdWallet, an “average” score means your credit score falls “between 630 to 689, on a range of 300 to 850.” These cards often come with higher APRs, but they offer a good way to build your credit.
Some cards may allow you to earn incentives – like a bonus cashback rate or a higher line of credit – after a certain number of on-time payments. Many card issuers offer online account access to do such things as view your card balance in real time and to monitor your payment progress.
For those with low credit scores, one option is a “secured” card that requires a cash deposit upfront when you open the account. The deposit is equal to your line of credit, so there’s less risk to the card issuer if you end up defaulting on your payments. Think of a secured credit card like paying a security deposit when you sign a rental agreement for a house or apartment — you’ll lose your deposit if you leave the rental in need of repair or renovation.
Positively, if you pay your balance on time and can responsibly manage the secured card, the card issuer will often upgrade you to an unsecured card. If the issuer doesn’t offer an unsecured card, you can receive your cash deposit back and apply for one that fits your needs (once you’ve had time to build that credit!).
Student Credit Cards
A “student” credit card is designed for 18-21 year-olds that have a little-to-no credit history. You are not required to be a student; however, these types of cards are often marketed to them directly.
If you’re under 21, the Credit Card Act of 2009 requires you to prove you have an independent income (e.g., income from a part-time or full-time job) or a co-signer that’s willing to put their credit on the line to help you build yours. If you don’t have a co-signer or independent income, then a secured card is the way to go.
Credit Card Benefits
Build or Repair Your Credit Score
A major reason to get a credit card is to build or improve your credit history. The better your credit, the more financial power you have. For example, you’ll need good credit to qualify for a mortgage loan or auto loan with a lower interest rate and better terms. You’ll also be in better standing with potential employers or landlords, who are sometimes required to check your credit before making an offer.
Unique to credit cards, you are protected by federal law against any fraud. This means that if there’s a fraudulent charge on your account, your card issuer cannot hold you liable for unauthorized charges over $50. Many card issuers offer zero-liability protection, so you will never be liable for any unauthorized use. They also often have advanced tracking systems in place to catch fraudulent behavior before it gets out of hand.
If your debit card is compromised, your bank or credit union will do its best to help you recover your money. However, you may not have card access to your funds until your new card arrives or until your claim is investigated and resolved. You may also not notice the fraud right away if your bank doesn’t have the sensitive tools in place to catch it.
Want that new television you’ve been eyeing? You might be able to earn all or some of it by simply using your credit card rewards, or with a new cardholder sign-up bonus. With a credit card, you’ll have a more flexible form of payment and you can learn to track your spending along with your perks and rewards.
Review: Credit Card Tips
Check your credit score before applying for a credit card
By checking your credit score before applying you’ll be able to figure out your potential options. If your credit score is pretty low, you may not want to apply for more exclusive credit cards until you’ve improved your score. Keep in mind that applying for too much credit in a short period of time can also negatively impact your score! Spend time to find the credit card that’s right for you.
Be aware of annual fees
Determine whether the rewards you will earn using your credit card outweigh any annual fees associated with the card. Not all credit cards have annual fees, but some do. For cards that do have annual fees, you may find that the sign-up bonus or the cash-back percentages are worth it because they will outweigh the fee, all depending on how and when you use your card.
Pay your balance in full (or as much as possible) each month
To avoid being charged interest, pay off your balance in full every month. Even better, pay off your balance in full before the due date — even weekly if you’re worried about overspending. Paying off your balance in full each month will help you build and improve your credit score, and you’ll avoid charges (and credit dings) that come with missed or late payments. If you can’t afford to pay the balance in full, pay as much as you can each month to avoid going into too much debt.
If you have a smartphone, turn on your notifications every time you use your card. These real-time alerts can usually be set up online after you establish your account. This will help to manage your expenses, as well as keep you in tune with your spending habits. You can also use an auto-pay feature through your checking account, which takes a lot of the guesswork out of monthly credit card payments. Familiarize yourself with a money-management platform that can help you view and manage your credit card balance in real-time.
Live and spend within your means
Finally, and most importantly, secure a steady income and savings account in case of any unexpected financial hardship. Don’t spend more with a credit card than you would otherwise spend with cash or a debit card. Just because you have access to a line of credit doesn’t mean you should use it in full — unless it is absolutely necessary AND you’re able to pay down the balance quickly.
Learn More About Credit Card Management at Lafayette Federal
Lafayette Federal Credit Union offers tools and resources to support the financial well-being of its members. We work with our members to provide the education they need to succeed — whether it’s for credit building, homebuying, fraud prevention, and more.
We’ve been helping our members take charge of their finances since 1935. Additionally, we offer a competitive credit card program with many features and benefits. If you’re interested in learning more, please contact us and we will help you get started.