When you pay by credit card, it doesn’t feel like you’re spending money. In fact, you’re not really spending money—you’re borrowing money. You know that you’ll have to pay the bill eventually, but the promise of small minimum payments can make purchases seem like bargains. Credit card companies are well aware of this psychological disconnect, and they take full advantage of it. That’s how so many people end up with overwhelming credit card debt. But if you know how they work before you start using them, you can turn credit cards into tools that help you build up a credit history and improve your financial situation, rather than the other way around.
On the plus side, using a credit card responsibly and mindfully can help you to establish good credit so when it’s time to buy a house or a new car you qualify for the best possible terms and lowest interest rates on the mortgage or car loan. Your card may also give back rewards, which can be valuable as long as you pay off the card every month. Most credit cards also offer purchase protection and other benefits. But the same cards that provide great convenience may become the means by which you end up thousands of dollars in debt, as purchases you make become much more expensive because of high interest rates.
The message of credit cards is one of instant gratification—you can have it all now. Credit card companies increase convenience at every turn. Their goal is getting you to use your credit card for everything and make the smallest possible monthly payments. They encourage you to overspend by dangling rewards in front of you. They discourage you from paying your balance in full by offering the option of minimum payments, which seem like monthly payments but aren’t. Credit card companies like it when you pay late (as long as you do pay), so they can increase your APR (annual percentage rate) and charge you penalties. After all, the more money you owe and the longer you owe it, the more money they make. And they’re in this to make as much money off of you as possible.
When it comes to getting credit cards, you have hundreds of choices. Major credit card issuers include Visa, Mastercard, and American Express. These card companies allow you to make purchases up to a preset credit limit ranging from $500 to $10,000 or more, depending on your income and credit history. You can pay the balance in full each month, the minimum required by the card company (typically around 2 to 4 percent of the balance), or any amount in between.
What Are Gold and Platinum Cards?
These are cards that include extra perks such as collision coverage when you rent a car, extended warranties on certain items, travel insurance, special discounts, and other exclusive benefits. They sound appealing, but you have to consider exactly what you get for the privilege of paying a much higher annual fee.
In-house credit cards, also called store cards, allow you to charge purchases at a particular chain of retailers, such as department stores and gas stations, and make monthly payments, including interest charges. Many retailers do offer certain advantages to their cardholders, such as additional discounts on their merchandise and exclusive shopping opportunities, particularly around the holidays.
There are several types of costs associated with credit cards. The annual fee is a flat dollar amount the issuer charges each year for the use of the card. Many, but not all, issuers charge annual fees. Finance charges are calculated based on the interest rate your card issuer charges and are the main cost of using credit. These rates vary significantly from one card to another, so you can save a lot of money by shopping around for a card with a lower interest rate. Other fees that you might incur on your credit card include application fees, processing fees, charges for exceeding your credit limit, late-payment fees, balance-transfer fees, and fees on cash advances.
The grace period, commonly twenty-five days, is the time between the date you’re billed and the date your payment is due. If you pay your entire balance within the grace period, you may not incur any interest charges. If you carry a balance, there’s often no grace period on new purchases, so interest starts accruing from the date of purchase. Some issuers charge interest from the day you make the purchase, even if you pay your balance in full, so in effect there is no grace period. When you add the fact that charges made at the start of the monthly billing cycle already give you a one-month deferral on payment, this grace period may result in a six-week, interest-free deferral on payment. The Credit CARD Act of 2009 mandates that the grace period, if offered, shall be for a minimum of twenty-one days.
Before you choose a credit card, think about how you intend to use it. If you pay the balance in full every month, the annual fee and other charges may be more important than the APR (the interest rate charged), so you should look for a no-fee or low-fee card. Even if the issuer charges an annual fee, you may be able to get it waived by calling and asking the company to remove it. If you carry a balance and pay for your purchases over time, the APR and the method of computing your balance are most important, so you’ll want to look for the lowest interest rate and the longest grace period.
Beware of teaser rates, which sound tempting because the introductory rate is much lower than the going rate on most cards. The downside is that if you have a balance on the card when the introductory rate ends, you could be in worse shape than if you’d had a higher rate all along, depending on how high the rate spikes at the end of the introductory offer and whether interest accrues all the way back to the original purchase date. It is also imperative that you make all minimum payments during the introductory period in a timely manner, or the rate will revert instantly to that higher rate.