"Too many people spend money they haven't earned, to buy things they don't want, to impress people that they don't like."
-- Will Rogers
Will Rogers died in 1935, but his wisdom holds true today. Millions of people are still overextending themselves to buy things they don't need and sometimes don't even really want -- and credit cards are making it very easy.
Still, credit cards aren't all bad. You can make credit cards work for you if you take the time to learn what a credit card is -- its definition and purpose and what it can mean for your finances. Then, when you get a credit card offer in the mail, you'll know what to do.
What is a credit card?
Let's start with the basics. A credit card is a piece of plastic issued by a company (typically a bank) that lets you charge purchases with it. It will generally send you a bill about once a month, and if you don't pay off what you owe in full, you'll be charged interest on what you have essentially borrowed.
A credit card is different from a debit card, by the way, because you can spend money you don't have with it. Debit cards take your purchase amount directly out of your bank account, making it hard to overspend. Both kinds of cards can look very similar, but while one takes your money immediately, the other is extending you a line of credit.
A little history can help put credit cards in perspective. Companies have been extending credit to consumers in many ways, all the way back to the 1800s and earlier. Some early forms of consumer credit included store cards and gas station cards, which let people charge purchases only at the associated businesses. One of the earliest multi-purpose credit cards that was widely accepted was the Diners Club Card, introduced in 1950 and initially meant to be used mainly in restaurants and for various travel purposes. American Express followed suit in the late 1950s and introduced the plastic card. Its cards expected payment in full each month. In 1966, Bank of America launched the BankAmericard general-purpose credit card brand, which has since morphed into Visa. Visa and MasterCard are the two top titans in the credit card world today, but there are many major players.
Kinds of credit cards
There are a handful of key credit card categories, each of which best serves certain kinds of consumers. Don't just jump and accept whatever credit card offer arrives in the mail. Instead, think about what kind of card will serve you best, and then do some digging to find the best card for you. It will largely depend on your financial health and your spending habits.
For example, if you're deep in debt, you'll need to pay off credit card debt and any other high-interest-rate debt as soon as you can. Balance-transfer credit cards and low-interest-rate credit cards can be good for that. Great balance-transfer credit cards will charge you no interest for a bunch of months while you work to pay off your debt, while great low-interest-rate credit cards can help you spend less on interest payments. If you're not deep in debt, consider getting a great cash-back credit card or two that will give you cash back or rewards that can be redeemed, delivering value. A particularly powerful niche in the reward-card world is the travel card. The best travel credit cards will reward you for your travel-related spending (often including restaurants) and/or will offer discounts on such spending.
If you do a lot of shopping, think about where you spend the most money, because many retailers offer cards that give you discounts when you shop with them. Lots of credit cards offer a range of extra perks, too, such as insurance on some purchases, free shipping from a retailer, or perhaps access to VIP lounges in airports.
Choose your card(s) carefully
Once you know which kind of card is right for you, you can drill down and take a closer look at some contenders in the right category. Here are valuable features to look for:
- No annual fee. Most credit cards don't charge an annual fee. Note, though, that if a card charges, say, $99 per year, and will deliver, say, $300 or more in value, then the fee can be worth it.
- No penalty APR. A penalty APR is what happens when card companies raise your interest rate, often to 25% or more, if you're late paying a bill. Look in a card's fine print to see whether there's a penalty APR, and perhaps avoid the card if it's there. Plenty of cards don't have this feature.
- No balance-transfer fee. If you're planning to transfer a balance, know that some cards will charge you about 3% to 5% of the amount you transfer from another card. That can still be worth it sometimes, but favor cards that charge no such fee, at least in the initial period when you make your transfer.
- Low interest rates. If there's a chance you will occasionally be carrying a balance, you should favor cards with a relatively low interest-rate range.
- No foreign transaction fees. Without this feature, if you spend money abroad or with a foreign-based retailer, you'll see currency-exchange-related fees on your statement.
- Access to your FICO credit score. It can be helpful to be able to check your credit score now and then, especially if you're working on paying off debt and increasing your score. Many cards these days let you see your score.
- Cash back -- or points or rewards -- that can be earned as you spend with your card. You can find cards that pay you 2% cash back overall on your purchases, and ones that offer up to 5% or 6% back on certain categories, such as supermarket spending. Some cards have pre-set cash-back rates for certain categories, while others rotate categories that earn extra-big rewards every three months -- sometimes even letting you choose the categories.
Stay out of debt
One of the most important things to do with a credit card is to not let it lead you into debt. Don't charge things you can't afford.
If you do let any debt accumulate, it can take on a life of its own -- especially when it's high-interest-rate debt. Imagine, for example, owing $10,000 on cards and being unable to pay it all off. If your interest rate is 20% and you just leave the debt there, you'll soon owe $12,000, and a year after that, you could owe $14,400. If you charge anything else to the card, your balance will keep growing.
Using credit responsibly
Aim to pay your bills in full and on time, every month. Even if your card doesn't impose a penalty APR, it could still sock you with a late fee of as much as $27 for your first offense and more than that for subsequent offenses. Paying bills late can also shrink your all-important credit score, costing you more whenever you want to borrow money.
If you do end up with credit card debt at some point, don't just pay the minimum required. Here's why paying the minimum is so counterproductive: Imagine you owe $25,000 on your credit card(s) and that you're being charged a 25% interest rate. If your minimum payments are 3% of your balance, you'll be starting out paying a whopping $600 per month, meaning you'll have to come up with $150 per week. If you make that $600 payment and all future 3% payments, according to a Bankrate.com calculator, it will take more than 30 years to pay the debt off, and your total payments will exceed $63,000 -- all for a $20,000 balance owed.
You'll receive a bill from each credit card you use each month. Take a minute to review all the charges. Are they all yours? If an identity thief has been using your credit card or card number to buy things, let the company know. You probably won't owe more than $50, if that -- even if a crook charged a new refrigerator to your card. (Some cards feature zero liability.) Fraudulent charges on credit cards are not uncommon, so be on the lookout for them. (Even a tiny unauthorized charge of a few cents should be reported, as it might be part of a scam in which the crook is testing lots of card numbers to see which ones work before making a big charge on the card.)
Finally, appreciate that having a good credit score is important, as it can get you lower mortgage interest rates, saving you tens of thousands of dollars. It can also get you approved for top-of-the-line credit cards -- ones with great terms, great benefits, and more. To keep your credit score high, pay off your bills in full and on time, and don't max out your credit limits on your cards. To get a good credit score, you need a solid credit history and credit report. Your credit report offers lots of details on your debts and repayment history, as well as a look at the credit you have, such as through credit cards. You're entitled to a free copy of our credit report annually from each of the three main credit agencies -- visit AnnualCreditReport.com to order yours -- and then check it for errors and fix any that you find. Your credit report won't include your credit score, but many credit cards these days give you access to your credit score or include it on each statement.
If you're deliberating over whether to accept a credit card offer or whether to apply for a card of interest, go ahead and do it -- as long as you will use the card responsibly. Be a savvy credit card user and you can benefit greatly, either getting help paying off onerous debts or collecting cash and rewards every time you use your card.