In their simplest forms, credit cards are lines of credit offered to you, upon which you make a monthly payment, which includes the monthly interest cost and some part of the balance that you owe. More on how this works later.
There are variations on that model, but that’s how most of them work.
Applying for a Credit Card
After researching the best card for you (more on that later) you either apply online or via a paper application which you mail in. It’s important to know that you’re applying with a bank.
This is important, because maybe you’re applying to get your favorite NFL team’s card. Maybe you’re an L.A. Rams or Baltimore Raven’s fan and want to show your team spirit. Great. But, just to clarify, you’re still applying with a bank, no matter who’s logo is on the front. The team gets a fee/bonus of some kind from the bank for marketing the card, but the card’s relationship is between you and the bank.
Assuming you’re approved, you will be issued a card with a credit balance and an assigned APR (annual percentage rate.)
Credit Balance: If you have no credit or low credit, you will be ssued a card with a smaller maximum credit balance. Use $1,500 as an example. This means that you cannot charge more than $1,500 on your card. If you try to do so, your charge will may be denied, and you will more than likely be charged an over-the-limit fee. Different banks work in different ways, and this gets a bit complicated, but best advice…stay under your credit limit.
If you have established, good credit, you will be awarded a higher account balance.
By the way, many banks will review your account on an annual basis and if you have made all of your payments on time, may reward you with a higher maximum balance. On the other hand, if you have missed a payment or two, they will lower your maximum balance.
APR: This is the interest rate that you will be charged on the balance. Again, if you’re new to the credit game, or have a low credit score, you will be charged a higher rate of interest. You have a great credit score? You will be charged a lower rate of interest.
There is some good news for those of us with low credit scores: Don’t use your entire credit card balance and make ALL payments on time, and you will be rewarded with a higher credit score, higher balances, and lower interest rates.
Believe it or not your monthly payments are a feature of your card just like the APR or the “bonus miles” you might receive.
Here’s how they work: Monthly payments are the combination of that’s month’s interest and a part of your balance due. Here’s an example:
Credit Card Balance: $4,000
Monthly Payment: 2% of your balance
Monthly Payment: $80.00
You might pay the minimum of $80 and think that you are “paying off the card.” That is technically true, but with example above, it will take you more than 27 years to pay that off. Yes, you read that right, 27 years. Why?
Because the banks take their interest first. So, go back to that $80 payment. About $60 of it will be interest. That means only $20 goes to pay off your balance. That means the next month’s balance is $3,980.
That’s why it takes so long to pay off credit card debt.
One more important thing about monthly payments. In the example above, the monthly payment is 2% of what you owe and that’s not unusual. Some cards may require 1.75%, some may require 3 or even 4%. Before applying, check that particular card’s monthly payment percentage. Can you afford to pay 4% (of balance) every month? Yes, you will pay it off faster, but does the higher payment fit into your monthly budget?
Credit Card Features/Perks
Credit card companies offer a slew of bells and whistles to draw you to their card…Airline miles, spend anywhere miles, 2-for-1 and more. And yes, you can get rewards and I have received them, but be VERY CAREFUL.
Are you paying for your own rewards? The simple answer is yes, absolutely. Maybe even more. First thing to look for is the annual fee. Fees often run as high as $50, $75, even $95 a year and more. That’s a lot of money.
I’ve chosen a card or two in my life for the perks. After a few years, I found that I had paid more in annual fees than my “reward.” I just bought my reward out right and saved myself a bunch of credit card fees.
But, I learned to look at credit card rewards in the following way. Given that all things are equal, the interest rate and annual fee are the same…if one card has a better rewards program than another, choose that one. But don’t think you’re getting something for free because you get rewards. You’re paying for them one way or another.
How Interest Works
Explaining how interest rates work could take us all week. They’re complicated. The best way to compare interest rates on credit cards is through the APR. Compare them and choose the lowest one? Does one offer 0% interest for one year and another 2.9% for two years? Think about how you’re going to use the card, and choose the one that fits that plan best.
A Credit Card Game Plan:
1. Determine how you’re going to use your card
2. Interest rates and annual fees: compare them from card to card and choose the one with the lowest combination of APR and annual fee.
3. Apply for one only. Get your feet wet and don’t be tempted to buy a bunch of stuff you don’t need, because it’s easy.
There’s one thing about having credit cards that’s quite the same as in life…you will only know what’s best for you after a trial and error. You will be smarter about credit cards after having a couple, than you know just starting out. It’s hard to know exactly how you’re going to be using your card. Once, you know a bit, don’t be afraid to transfer to one that better suits your needs. Good luck in your credit card endeavors.