Having and using a credit card correctly has great advantages when it comes to improving your finances. Not only is it the first step toward gaining a good credit history, but it also can provide you with benefits while doing so.
The benefits of this are clear: If you ever need money for a project or unforeseen situation, you will be able to get it immediately. No matter if you are looking to create your own business or buy a home, this is extremely important. You’ll also have the option of accessing other financial products such as education, automotive, mortgage, or payroll loans.
Thanks to credit, people, companies, and States can have access to resources that would otherwise be difficult to obtain. While here at Turbowallet we focus on personal finances, it is important to highlight that the scope of credit is bigger than most people realize.
It is essential to always remember that a credit card is not something to take lightly. You should make sure your level of debt is kept at acceptable levels at all times. This is because failing to repay your credit cards can be disastrous for your financial life. A credit card has the potential to be an extremely useful asset or a financial liability.
If you are a frequent reader, you know that we are all about improving your financial life. As such, in this guide, we will be telling you everything you need to know about credit cards: What are they? How do they work? What is a credit score? And more! Let’s take a look at the basics in this credit card 101 article!
How Does A Credit Card Work?
As you probably know, credit cards are essentially payment cards issued to cardholders by a bank or a financial service company. It’s an agreement in which the issuer creates a revolving account and grants the cardholder a line of credit.
In other words, you can borrow money instantaneously until you reach a certain limit. By doing so, the cardholder (you) agrees to pay the issuer for the accrued debt. This debt includes the price of the product or service and any additional charges agreed upon.
Let’s also go over another key term we just used: revolving account. This is an account in which the customer can incur debt without having to apply and be constantly approved. On top of that, the benefit of a revolving account is that the borrower does not have to pay the whole debt accrued every month.
If you get a credit card, you can just pay the minimum amount; the remaining will ‘revolve’ over to the next month. This is why you can choose to use a credit card to pay for a product in installments.
That doesn’t mean that you shouldn’t try to pay every month, though. Not paying the full amount will result in you paying interest. In addition to this, if you fail to pay in time, your credit score might be negatively impacted.
Paying For Goods and Services
Here we get to the meat and potatoes of the matter. The main function of a credit card is paying for goods and services. But what exactly happens when you purchase with a credit card? First, your card details are sent to the seller’s bank.
The transaction is authorized by the credit card issuer, which verifies the information and hopefully approves the transaction. At that point, the seller gets paid, and you receive what you paid for without giving cash upfront!
When this happens, your available credit is reduced by the amount that the item or service cost. You will not have to worry about paying back until your billing cycle ends.
Once it does, you’ll receive a statement with all the transactions you made, your previous balance, and your new balance. You’ll also be informed of your minimum payment and the due date. Now it is a matter of paying back to your credit card issuer.
It’s as simple as that. Once you pay the debt, your available credit will bounce back up to the credit limit. You can now use your credit card again to its fullest, and your credit score will improve. Easy, right?
Well, there are some things that you need to be aware of when handling your credit card. For one, the grace period. If you pay your current cycle’s incurred debt before the due date listed on the statement, you won’t be charged interest. This time between the date of purchase and the due date is known as the grace period. If you don’t pay during this grace period, you will incur interest charges. Let’s talk about that.
What Is An Annual Percentage Rate?
As we already mentioned, not paying your full balance and carrying debt over will accrue interest. This is where you’ll see terms like the ‘Annual Percentage Rate’ or APR. This is an annual percentage of interest and other fees charged on purchases that are added monthly. Now, this may sound confusing, but in practice, it is not that difficult. Let’s take a look at an example.
Let’s say that your credit card has an APR of 21%. Dividing this by 12 will give you the amount that is added to your outstanding balance monthly.
This means that 1.75% of the outstanding balance will be added to what you owe at the end of the billing cycle. If you have an outstanding balance of $100 at the end of your billing cycle, you will have to pay $101.75. See? It is not that hard despite the confusing acronyms.
What you need to consider is that a higher APR simply means higher interest for outstanding balances. So when you’re shopping for credit cards, you want to see a lower APR.
Many new credit card users make the mistake of making the minimum payment each month. This is not great as it will result in higher interests being paid over time. By paying more, or even the totality of the debt, you will ensure your credit life doesn’t get out of control. This is in addition to saving on interest.
What Are Cash Advances?
Now, you’re not always limited to just making a purchase with the credit card directly. Some cards also have other features like cash advances. These will let the customer borrow money in the form of cash. It’s kind of in the name there.
Cash advances can generally come with different terms and conditions that need to be agreed upon. While credit cards are accepted almost everywhere nowadays, this may be an alternative if you are still working with some cash-only merchants. Do however note that these can come with higher fees. This is why you want to avoid cash advances as much as possible.
This gives you a small insight into how credit card companies make money. If you want to know more about that topic, check out our full article on that topic here. Knowing how the credit card companies make money will help you stop them from taking yours.
What Is A Credit Score?
We’ve mentioned the dreaded credit score earlier in this Credit Card 101. You probably have heard about this term before and are aware it is something important… Well, it is. What credit cards and other lines of credit are available to you depends entirely on this number. But what exactly is it?
A credit score is a three-digit number that describes your creditworthiness. This is an estimation by the credit reporting bureaus on how likely you are to repay your debts. The higher the score, the better you look to potential lenders.
We’ve already gone over this topic in another article, so if you’re looking for more insight; you’re covered. For a deeper definition on the matter, feel free to check that out here.
Having a good credit score will open different card options and offers to you. Lenders want to lend you money if they believe that you are a good borrower. Credit cards available to people with better credit scores have lower APR, lower fees, and better rewards for making purchases.
If your credit score is low or nonexistent, your options are significantly reduced. You’ll be seeing higher fees and little to no rewards. This is why you want to be looking at how to improve your credit score at all times. We’ve covered how to improve your credit score in another article, so if you want more information on it, you can check it out here.
What Makes a Good Credit Card
Finding the right credit card can seem like a difficult task because of how many options there are. Add to this that all of them have slightly different terms, enrollment bonuses, rewards, and fees… This is why so many people can feel overwhelmed.
Different Types Of Cards
There are several types of cards to choose from, and there is no going around that. However, there are several aspects you can consider to choose the best one for you.
For example, if you already have debt, you should focus on one thing: finding a card with the lowest possible interest rate. This will ensure you don’t get overwhelmed by interest resulting from your credit.
If you are planning to use the card regularly, you can expand your search to the different cards that reward your expenses. Some may offer cashback, miles, or points. Which one is best depends on you.
This means that what is best for you may be different from what is best for another person. Keep your own financial state in mind when choosing a credit card. That being said, there are several aspects you want to consider when choosing a credit card.
Choosing The Right Card For You
First, you want to take a good look at the fees and costs. Some cards will have late and even transaction fees. This will define what you can do with your card. Knowing what you’re getting into is imperative.
This is quite obvious, but it is something that has to be noted. Remember: Lower fees don’t mean a better card. It is better to pay $50 to save $2000 a year than not paying anything but saving $1000.
Secondly, look for low-interest rates. However, keep in mind that these are not always fixed and can change in the future. On top of that, if you have a better credit score, your interest rates will be lower. Remember that interest rates can be avoided if you are smart about it!
Check out the rewards that the potential card provides. This will depend on your spending habits. If you do think that you’ll use them, take advantage. If you don’t think you will, and they’ll cost you extra, stay away. Go for rewards you can really benefit from!
We have to reiterate that you need to read the contract carefully and with time. You should even do prior research before you get into it. If you are looking for reviews and our suggestions on cards, check out our reviews here.
Types Of Credit Cards
As you have seen so far in this credit card 101, not all credit cards are made equally. As such, there are different types of credit cards you can use to categorize them. By understanding these types, you will have a better idea of what to expect. Let’s take a look at the different types of credit cards.
Vanilla Credit Cards
Vanilla credit cards are the most basic of the bunch. These cards are there for those who enjoy the simplicity and are just looking for a credit line.
The lack of other perks is compensated with fewer or no fees. This also means that the terms and conditions are much easier to understand. You don’t have to crawl through the fine print to understand what you’re getting with them. It’s as simple as that.
Options might be limited for those with a bad or no credit history. If this is your case, you should be looking at Credit Builders. These cards tend to have lower credit limits and higher APRs but tend to be easier to be approved for.
These lower credit limits and higher APRs are in place because they are geared towards riskier borrowers. In that vein, they come in two types: secured and unsecured. Secured credit cards will have you pay collateral as a security deposit for your borrowing. The credit limit usually will be equal to that security deposit.
Unsecured credit cards, on the other hand, do not need that security deposit. Note that many credit builders can come with annual fees, so check the contract before getting into them.
Credit builder cards are there for users who want to improve their credit scores. Once the score has successfully been improved, these are generally left by the wayside as better rates and rewards are available.
Reward Credit Cards
If you like getting nice treats, you may be looking at getting additional rewards for using your credit card. This is available with Reward Credit Cards. Now, these rewards can come in all different forms and sizes.
Some cards will give you cash back rewards on your purchases. This cashback can be used to pay your debts or make other purchases. These types of cards are excellent for those that like the flexibility that cash rewards provide. If you’re looking for more information on cashback credit cards, check out our full reviews on them here.
Other cards offer you points rather than cash back. You earn points by making everyday purchases, and they can be redeemed for a variety of things. For example, points can be redeemed for flights, gift cards, services, products, etc.
The amount of points and what they can be redeemed for varies depending on what card you have, so it is important to check what the rewards are before signing up so that they work for you.
Now, these are only a sample of the different credit card types that may be available to you. What is best for you depends on your spending habits. This means that you have to review your particular case before you decide.
We have now got to the end of this Credit Card 101. As you can see, there are more things to consider when getting a credit card than just interest rates. By carefully considering your options, you can ensure your financial life improves instead of deteriorating. After all, that is the whole purpose.
Always remember to keep your finances in mind when using your card. As you keep good credit habits, your credit limit will increase. However, stick to what you can easily handle.
All in all, a credit card is an amazing tool to have in your financial tool belt. Learning what you can do with it and how to make the best of your tools is important. Not every task needs a hammer. Having a variety of financial tools for different uses is a great asset.
We hope to have given you an insight into the workings of credit cards and how you can learn to use them. If you would like to know more about what credit cards you can apply for, make sure to check our credit section!
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