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Using credit cards wisely is a lesson I continue to learn. So I asked my friend, Nick True, to share his best advice for those who are beginning to use credit… and those – like me – who have tremendous experience with debt.
Credit cards are the worst.
They’re confusing and unfortunately, most of us never learned the details about them. I was so confused during my first year of having a credit card that I paid it off every week because I didn’t understand the billing cycle.
But even though credit cards are confusing most of us don’t ask for help because it makes us feel stupid. We think other people probably understand it easily, so we’re embarrassed when we don’t get it.
The problem is that credit card companies know this and they make it confusing on purpose so that you’ll mess things up and pay them more money. It’s why so many people are scared of credit cards today.
Luckily, there’s no reason to be scared. Yes, credit cards can get you in trouble, but if used wisely, they offer some great benefits. If you’re new to credit cards, or just have a hard time understanding them, this guide is for you.
How Credit Cards Work
In the simplest terms, a credit card is a financial account that lets you take a small, short-term loan. When you use one, the company applies a “credit” to your account to cover the purchase and then you promise to pay them back later. Hence “credit” card.
This is different from a debit card that actually takes money from your account immediately.
Because credit cards are essentially loans, they typically have a specific interest rate that you owe on the money. But unlike most loans, you can use credit cards like an “interest-free loan” if you use them wisely.
If you pay your bill in full every single month, you’ll never pay any interest on your credit card. I’ll explain exactly how to do that below.
Terms And Fees You Must Look Out For
Before you dive head first into using a credit card, you need to understand exactly what you’re signing up for.
The problem is that nobody actually reads the 50 pg. 8 point-font terms booklet. And I understand. Most of us would rather clean up poop smeared on the wall by our toddler than read the credit card terms and conditions.
The good news is, there are only a couple of terms and phrases you need to understand, then you’re good to go.
Annual Percentage Rate (APR): This is the amount of interest you will pay on purchases over the course of a year. If you pay your bill in full every month though, you’ll never have to worry about this number.
Closing Date: There are two dates you need to know. The first is the closing date, which marks when a single cycle for a group of purchases ends. For example, if your closing date is on the 4th of every month, all purchases made between June 5th and July 4th will be on one bill. The next bill cycle will then run from July 5th to August 4th and so on.
The Due Date: This is the date that your bill is actually due. For instance, if your due date is on the 1st of every month, that means for the billing cycle between June 5th and July 4th you would need to pay that bill by August 1st.
Penalties for Late or Missed Payment: Your credit card company will hit you with this fee if you are late or completely miss a payment. For example, my Discover It card has a late payment fee of $35.
Annual Fee: This is a yearly fee that some cards have. I recommend against cards with a yearly fee, unless you’ve crunched the numbers and that specific card gives you more cash back than any other no-fee card. But that is very rare. Most of the time, it’s best to just avoid annual fee cards.
There are some other terms that may be helpful as you get more advanced, but focus on the terms above, and you’ll be set for now.
Understanding The Billing Cycle
I get more questions about the billing cycle than anything else when it comes to credit cards. And it’s no wonder why, the billing cycle is confusing as all get out. So I want to dive a little deeper into this topic.
First, you must understand that credit cards work on a monthly basis. But that doesn’t mean you have to pay for what you purchase by the end of that same month.
Here’s an example.
Pretend I have a card with a statement end date on the 4th of every month and a due date on the 1st. Now, say I spend $50 at Target on June 6th. That $50 charge will be on my statement for June 5th – July 4th.
On July 5th, I will receive an email from my credit card company that says my statement is ready. Again, that bill is for all purchases between June 5th and July 4th. But the bill isn’t due until August 1st. This means that I don’t have to actually pay the credit card company for my $50 Target trip until almost 2 months after I went.
I know, I know, confusing. Here’s a diagram to help you out.
If you still have a hard time with credit cards, just know you’re not alone. I didn’t understand this at all when I got my first card. Since my payment due date was on the 1st, I thought that I would need to pay for my $50 Target trip from June 6th by July 1st in order to avoid interest.
But that isn’t the case.
As long as you pay for all of the purchases between June 5th and July 4th by August 1st, you won’t get charged any interest. It’s effectively a 1 & 1/2-month interest-free loan.
If you hear someone talking about paying their credit card bill “in full”, that’s what they’re talking about.
How Credit Card Companies Make Money From You
It’s important to understand how credit card companies make money so that you can avoid it. Luckily for them, they have a variety of ways they make money off you. Ultimately these ways break down into three categories.
Credit card companies make a lot of money by charging annual fees, overdraft fees, late payment fees, and cash advance fees. You should never have to pay any of these fees if you’re using the credit card wisely.
Basically, you should cut up your credit card right now if you are regularly paying any of the fees listed above. If you want to grow your wealth and have money to take care of your family, these fees will hold you back.
Another major way these companies make money is by charging the store where you buy stuff a percentage of the sale. Typically they will receive between 1% -4% of the purchase price when you buy.
Lastly, credit card companies make lots and lots of money by charging you interest.
The vast majority of folks in piles of consumer debt are drowning because of their credit cards. Unfortunately, credit cards are one of the easiest things to get and also one of the quickest ways to kill yourself financially. Most credit cards have interest rates between 15% – 24% which is unbearable if you’re living outside your means.
A rate like that will absolutely keep you from reaching your dreams.
If you are carrying a balance on your credit card and not paying in full, you cannot handle it. Period. You’re not a bad person, it just means credit cards probably aren’t for you right now. You will never reach financial freedom while carrying credit card debt. If that’s you, cut them up and start working on
You’re not a bad person, it just means credit cards probably aren’t for you right now. You will never reach financial freedom while carrying credit card debt. If that’s you, cut them up and start working on your debt free plan ASAP.
How Credit Cards Affect Your Credit Score
It’s also important to understand how credit cards will affect your overall credit rating specifically, the FICO score. Your FICO score is broken up into 5 categories.
- Payment History (35%)
- Amounts Owed (30%)
- Length of Credit History (15%)
- Credit Mix in Use (10%)
- New Credit (10%)
You can see that the payment history and amounts owed make up 65% of your credit score combined! So focus a lot of your energy here.
The payment history is simply a score based on whether or not you paid on time.
Amounts owed has to do with how much credit you consistently use each month vs. how much you have available (typically called a credit limit). You should aim to keep the ratio of credit used to credit limit below 20% for a top notch credit score.
Credit cards only minimally impact the other factors in your credit score. The length of credit history is based on how long accounts have been open (longer is better). Credit mix looks at your variety of credit like student loans, car loans, mortgage, and credit cards.
Lastly, new credit is a reflection of how often are you applying for new loans or credit cards (less often is better).
Basics of Credit Card Rewards
Credit card rewards are earned by making purchases and come to you in the form of cash back or points. Depending on the credit card, these rewards can be redeemed in a variety of ways. I’ll explain the most common below.
Direct Deposit: This is the easiest and most straightforward way to redeem your rewards. A lot of credit cards will let you convert points into cash and then directly deposit the money into your bank account. This is my personal favorite way to redeem rewards and it’s definitely the simplest to understand.
Statement Credit: This option is similar to the direct deposit because it’s typically related to an exact dollar amount. The company just takes your reward and lowers your bill by that amount. Easy peasy.
Travel Statement Credit: A travel credit is a specific type of statement credit that travel rewards cards typically use. These credits are just like normal statement credits except that you can only use the points if you are reimbursing yourself for a travel expense like flights, hotels, and rental cars.
Online Shopping: Many credit cards will now let you use your points or cash back directly with stores online. Instead of putting the money into your bank account and then buying something you can just purchase it directly. Amazon, for example, allows tons of credit card companies to link directly to them and let you use points on their site.
Gift Cards: Another popular way to redeem rewards is using gift cards. My wife and I did this recently because one of our credit cards was giving us $50 Sam’s Club gift cards for only $40 of cash back. It was such a good deal we ended up getting a bunch of gift cards using cash back and bought a nice TV with the money.
As you can see, there are lots of ways to use credit card rewards, but every credit card will be different. Be sure to understand the types of rewards available to your specific card and see what makes sense for you and your own shopping habits.
How To Get In Trouble
It’s easy to get in over your head when using a credit card. The quickest way to get in trouble is to let one month go by without paying the bill in full.
Using a credit card responsibly is a habit. Which means it takes a lot of time to build but it doesn’t take much time to break. It’s a lot like working out. When you work out 5 days a week, it’s easy to get into shape. But when you miss a workout for the first time, it’s easy to miss another, and another, and another.
That’s how credit cards work.
The first time you don’t pay off your bill completely, you’ll start to build a bad habit and it’s easier to do that again next month.
Nobody wakes up one day and purposefully tries to gain 50 lbs. And nobody tries to get into $20,000 of credit card debt. Yet it happens every single day.
So if you’re going to use credit cards, make sure you’re paying the bill in full every single month. If not, cut it up.
How To Not Get In Trouble
Saying you’re going to pay your credit card bill in full every single month is easy. Actually paying it off in full, however, is much harder.
If you’re serious about using credit cards wisely, you need to make a plan. That means a budget. Budgeting is the only way to consistently spend below your means if you’re using a credit card.
With a debit card, you can always check the bank balance and see what you have left. But because credit cards aren’t immediately connected to your bank account, you’ll have to budget in order to stay on track.
Top 5 Things For Using Credit Cards Wisely
In summary, I want to hit on the 5 rules you should be following in order to use credit cards wisely.
But honestly, the number one thing you can do is to focus on creating a budget that works well for you and your family. When you start budgeting, you’ll only use the credit card for things that you can afford to buy. That’s how you use credit cards wisely.
If you don’t know where to start with budgeting, I highly recommend using a budgeting app like YNAB. That’s what my wife and I use, and it has been a huge help to our finances.
Outside of budgeting, here is a list of rules that will recap all of the things you should be doing to use a credit card wisely.
Rule 1: Pay the bill on time and in full every single month
Rule 2: Never carry more than 20% of your credit limit on the card
Rule 3: Never get a card with an annual fee (unless calculations prove otherwise)
Rule 4: Read and understand the major terms and agreements for the card
Rule 5: Never make excuses for breaking these rules
Credit cards are like most things. When you use them wisely, they provide a ton of benefits. But if used poorly (pun intended), they can cause a lot of problems. All things in moderation.
More about Credit Cards and Debt
- 5 Unique Ways To Pay Off Debt You Haven’t Thought Of Before
- 8 Simple Ways to Start a Savings Fund
- Free Family Finance Binder Printables
- 5 Myths about Bankruptcy and the Truth from Someone who Survived Chapter 13
- How to Negotiate with Credit Card Companies
- Recognizing the No Payments No Interest Credit Card Trap
Nick True is a married twenty-something from Tennessee and father to three fur-children. He’s a professional writer and specializes in personal finance for millennials. Nick loves helping people create a personal plan with their money, based on their own tendencies and emotions, via his website, Mapped Out Money.
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