This post came to fruition from a conversation with someone about the way credit cards work. For most, they think its free money but we all know this isn't the case. Let's breakdown credit cards a little.
A Little History of Credit Cards
The idea of credit didn't start with the creation of physical credit cards and charge cards. This idea dates back to 1700 BC when farmers would agree to pay off their credit at a later time, typically when their crops were harvested. As time goes on, lenders and borrowers operate on the revolving credit model. This means that you can use the credit or credit card over and over until the limit is reached. Any balance left on the card would accrue interest until paid. This model allowed borrowers more flexibility but also afforded the lender the opportunity to profit off the interest.
Various methods of tracking this revolving credit would be used until Diners Club Card created the first credit card (cardboard in nature) that could be used with various merchants in 1950! My mom had a Diners Club Card in the 90s. YIKES, lol. 8 years later, American Express would introduce the plastic charge card and the credit card industry would continue to morph and change into what it is today.
What's the purpose
So if credit cards aren't free money, then what is the purpose of having one? Having a credit card and showing that you can pay off what you borrow within the specified time frame, builds your credit. Credit is needed for a variety of things from purchasing homes and cars to getting loans. In some instances, employers may need to see your credit as a condition of being hired. Lenders want to make a sure you are reliable and they use your credit to make that determination.
Types of Cards
There are many different types of credit cards available to pretty much anyone that applies. Whether you get the card is based on income, credit score, past financial history and a host of other factors, but that's another post.
The Main Card Types include:
Charge Card - Don't carry a revolving balance; must be paid off at the end of the month; Think American Express (AMEX) (they do have revolving ones as well)
Revolving Credit Card - You can carry a balance and still use the card; interest is accrued for the remaining balance each month; Think Visa and Mastercard;
Store Card - Typically revolving but for a specific store or company; Think Macys, Target, Walmart
Rewards Cards - Typically revolving that offer a reward for using, cash back, airline and hotel points, discounts on services; Think Capital One Venture, Branded AMEX Cards, Time share a vacation rental cards
Prepaid Credit Cards - Can only be used if there is money loaded to the card, similar to debit cards but aren't tied to a checking account; Think Rush Card, PayPal Prepaid
NOTE: These cards can either be **secured (**require a security deposit of sorts; carry higher APR's; no credit score minimums) or unsecured (lower APR's; don't require a deposit; credit score minimums).
Each of these card types have options for the following:
Student - geared towards students who may have limited or no credit; they also tend to have lower interest rates (I had a bunch of these in college because I wanted that free t-shirt. Just Say No!!!)
Business - For the business owners, comes with lots of benefits to a business and helps establish credit.
Everyone else 🙂 - The rest of us!
Understanding Fees, Payments, and Rates
You have a few card types in mind. Now what? Understanding all the fees and rates associated with them can help you choose the best credit card for you. The most common fee is the Annual Percentage Rate (APR). This is the total amount of interest you pay each year on the balance of your credit card debt. All credit card companies are required to share what their APR's are. In the example below, the APR for purchases is 18.99%. As you can see, cards tend to have various APRs based on how you use the card.
To calculate your monthly interest, do the following:
NOTE: 0% Introductory APR's are GREAT!!!! But be careful. While you aren't paying any interest during the introductory period, interest is still accruing on the balance. If you miss a payment or don't pay the entire amount by the end the period, ALL the accrued interest will become due. This could be 1000s of dollars.
When is interest charged
Real Life Example: We have a Capital One QuikSilver Card. It provides cash back on purchases and has been pretty decent thus far. The billing cycle (between 28 and 31 days) usually ends around the 13th of the month. The payment is due by the 7th of the next month. The time in between is considered a "grace period" where no interest is charged. Any new purchases that are paid off by the 7th will not accrue interest. However, if there is a balance from the previous statement that was not paid off, you will be charged interest.
In addition to the APR fees, there are also different types of fees that may vary from card to card:
Annual Membership Fees: All cards do not have these, but for those that do, consider the benefits you get for paying a membership fee. American Express Platinum has a very high annual fee however for that fee, you get access to all the Centurion Lounges in airports, Priority Pass Lounges and Restaurants, discounts on transportation and travel, discounts in store, a full on concierge service and more.
Late Fees: If your bill is paid after the due date or not even paid. These can start around $29.
Foreign Transaction Fees: Fees charged when using your card in a foreign country.
Cash Advance Fees: Fees to take cash off of your credit card. This rate is typically higher than the purchase rate.
Returned Payment Fee: Similar to what banks charge for bounced checks (yeah I still carry checks). Another reason to make sure you have the cash in your account to make that payment.
Over the Limit Fees: Yes you can use to the limit but if you go over, you will be charged.
Balance Transfer Fees: The fee for transferring a balance to the card.
All in all, depending on your current financial situation, credit cards can provide a number of benefits as well as heartache. Here are a few final thoughts. It's up to make good choices!
Final Tips
Understand WHY you want or need a credit card: Improve credit, reduce debt, etc.
Only use what you can reasonably pay back. Rule of thumb: If you don't have the cash in the bank, don't use the card.
Do your research on the cards and compare.
Stay away from Variable APR cards if possible. Your interest may end up being higher than it should be.
Pay your card in full each month before the due date.
READ THE FINE PRINT. It tells how payments are applied and how interest is charged.
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