Whether you already have a credit card or are thinking about getting one, it’s time to get acquainted. Here’s what you should know.
What is a credit card?
A credit card allows you to borrow money to make purchases and then pay back later. How much you can borrow is based on your credit, or your trustworthiness to pay back the money. There is also a time limit to pay back the money before interest starts to multiply on the original amount borrowed.
Why use credit cards?
Credit cards carry several advantages:
- Use credit cards in place of cash, which can be bulky in your wallet.
- Build and maintain credit history. Mortgages and other loans will often check how well you handled past payments. Did you pay on-time?
- Earn perks like travel miles or shopping points, and sometimes even cash back, with certain credit cards.
What are some key costs of using a credit card?
- Finance Charges – Do you carry a balance on the credit card after it is due? Then you owe interest on the borrowed money, otherwise known as finance charges. These get calculated as an annual percentage rate, or APR. If you pay in full each month, you have no finance charges.
- Late Fee – Don’t pay your credit card on-time? There’s a fee for that.
- Balance Transfer Fee – Trying to move other debt to your credit card, so that you can capture a lower interest rate? Doing so incurs a balance transfer fee, usually a percentage of the amount to be transferred.
- Annual Fee – Some credit cards carry such good perks or low finance charges that it costs you money to use them. Using these types of credit cards is wise only if the perks outweigh the annual fees.
As you can see, most of these costs don’t apply if you pay your credit card in full each month. Thus, it is actually possible for the cost of using credit cards to be zero!
How does credit card debt happen, and how do I avoid it?
As long as you pay off your credit card in full every time and on-time, you won’t fall into debt. In fact, it should be the only way to use credit cards. Unfortunately, credit card companies give the option to pay a minimum amount, typically 1%-2% of the total credit card balance. Paying the minimum causes the remaining balance to rack up interest, adding to the cost of what was originally borrowed.
To illustrate the real cost of carrying a balance on a credit card, let’s use this example. Say you buy a bike for $100 on a credit card with 18% APR (annual percentage rate). $100 x 18% = $18. You actually pay $18 more dollars on that bike if you let that debt sit for a year. If the credit card company calculates on a monthly or daily basis, and most do, that bike will cost even more. Much like compound interest on investments, debt multiplies itself over time. Avoid debt altogether by buying only what you can afford and paying off the balance in full each month.
Parents can introduce credit cards using a 3-step approach. 1) Start with gift cards. What’s great about gift cards is that you can only spend what you have and nothing more, but you are required to spend in only one place. Nowadays there is the option to get gift cards to use wherever credit cards are accepted. 2) Get a debit card to allow for spending anywhere, keeping within the limits of what is available. A debit card requires an attached bank account to pull funds from, so you will need to set one up if you want children to access their own money. 3) Graduate to the credit card! Only keep the credit card if every statement is paid in full.
Credit cards: Good or Bad?
Only you can decide whether credit cards are good or bad for you. If you can commit to paying off your credit card in full each month, there really is no disadvantage to keeping or getting one. Choose what’s right for you!
Tune in next week to learn about the 401(k) plan. Is it a type of investment? Is it a savings account? Subscribe below to automatically receive weekly lessons in your inbox!
Homework: Know what credit cards are charging you. Become familiar with the costs before getting a credit card, and choose the right one. If you already have a credit card, is it the best one for you?
! LinkedIn Readers: If you would like to continue these weekly lessons, please bookmark Ace-Academy.org or subscribe below! This will be the last post available on LinkedIn.