What to know before getting a credit card is an incredibly important life lesson.
Chances are when you turn 18 or enroll in college, credit card companies and banks will begin sending you offers to sign up for their cards.
Credit cards have many benefits. Using one responsibly is essential to building your credit.
Credit cards can be dangerous, though.
Choosing the wrong card or using it irresponsibly can lead to financial ruin. Credit card debt can take you years to get out of if you even can at all. Misusing your credit card can be tempting, especially at an age where you are experiencing many new freedoms.
The best way to ensure you’re using your card in a way to strengthen your financial future is to educate yourself on credit cards themselves. Understanding the basics of credit cards, including how they work and how to avoid pitfalls, will set you up for success.
Keep reading for our beginner guide to credit cards.
Secured vs. Unsecured Cards
When it comes to choosing a credit card, knowing the difference between a secured and an unsecured card is critical.
With a secured credit card, you will make a cash deposit to establish yourself as a borrower. This cash acts as collateral and reduces the risk for the lender if you don’t pay off your balance.
Unlike a prepaid card, your cash deposit does not deplete as you incur a balance on your card. You will make payments and pay interest just like with any other credit card.
If you cancel the card or upgrade to an unsecured card, you will get your deposit back. This is a great option for those without a strong credit history.
Unsecured cards are more common. These do not require any collateral.
Your credit limit gets based on your income and credit history. If you do not have much credit history, you might need to start with a secured card or have a cosigner on your unsecured card.
You will also likely start with a low credit limit as the risk to the lender is greater. If you have no experience with credit cards, consider getting added as an authorized user on the account of a family member or friend.
This will help you build credit and establish yourself as a trustworthy borrower.
One of the trickiest parts of having a credit card is understanding how interest gets calculated.
While many people assume that interest is determined by how much is left on the card after the monthly due date, this is not correct. In fact, if you don’t pay off your entire balance each month, interest will accrue based on your average daily balance over the course of the month.
Your card’s annual percentage rate or APR can be used to calculate your periodic interest rate. You’ll take your APR and divide it by 365.
Then, take this number and multiply it by your average daily balance and the number of days in the month. This figure is the amount of interest you will accrue for the month.
You should aim to pay your balance in full each month. If you are living within your means, you should not need to pay interest.
Making just the minimum monthly payment will keep you afloat but can lead to a snowball effect of credit card debt.
The Grace Period
One of the best things about using a credit card is that if you use it responsibly, you can use it as an interest-free loan by taking advantage of the built-in grace period.
Most credit cards have a billing cycle that allows you to make purchases interest free by giving you a grace period of 21 to 25 days. If you pay your balance in full when you receive a statement, you won’t pay interest and you’ll build credit.
Keep in mind that if you use your credit card to get a cash advance, you may be subject to a higher interest rate and might not get a grace period for repayment.
To stay in good standing with your lender, protect your credit score, and avoid late fees, you’ll need to make at least your minimum payment each month.
Check with your lender to confirm how they will determine your minimum payment. Some lenders will calculate your minimum payment by simply charging you a percentage of your balance.
If your balance is low, you may only get charged a flat fee each month.
If you carry a balance and make a payment late, your lender may charge you a percentage of that balance, your accrued interest, and any incurred fees at the end of the month.
Your Credit Score
Credit cards have a major impact on your credit score, for better or worse.
Credit cards affect your credit score in many ways. Your payment history, open accounts, new credit, length of credit history, and credit utilization get taken into account.
Credit utilization is a calculation of how much of your available credit you are using. This is calculated per card and on an aggregate level by looking at all of the accounts you have open.
You should not use more than 30% of your available credit.
Credit cards come with many fees, but you can avoid most of them.
You may get charged a fee if you go over your limit, make late payments, make foreign transactions, or transfer your balance to another card.
Some cards come with annual fees, but these are usually cards for big spenders that come with rewards or cards for high-risk borrowers.
The best way to avoid paying unexpected fees is to understand the terms and conditions of your credit card and communicate with your lender.
The 101 on What to Know Before Getting a Credit Card
This introductory guide on what to know before getting a credit card has provided you with the basics.
The truth is, the decision to get a credit card and the type of card that you should get comes down to your individual circumstances.
Contact Bonsai Finance today to learn more about getting your first credit card.