Credit Cards: Friend or Foe?
How do Credit Cards REALLY work?
Credit cards have been officially around since the 1950s and have become a large part of consumer culture ever since. Even though credit cards aren’t new financial products, many people still don’t understand how they work. Lucky for you, we’re here to break things down and help you make sense of things. Now let’s talk credit cards!
What’s the price we pay for the things that can’t wait?
From buying Starbucks to paying for a tropical vacation, a credit card is an awesome piece of plastic filled with money that you never have to pay back. If this sounds too good to be true, you’re right, and that’s why Americans are expected to pay over $100 Billion dollars in interest and fees to banks and credit card companies in 2019.
To the average person, credit cards often feel less like a ‘back-up’, and more like a ‘boost’ to their available money. Unfortunately, this temporary sense of comfort has become a constant sense of panic for many people. A recent study by the Center for Financial Services found 7 in 10 adults in the United States are struggling financially while 3 of those 7 Americans believe they will never get out of debt.
How do credit cards REALLY work?
Now, as we mentioned in our article How to Manage Your Money when you use your magical piece of plastic known as a credit card, the bank gives you a grace period in which you should be paying them back for the money they’ve lent you for your purchases. If you don’t pay your balance in full, they charge you interest, which is where the compound interest comes into effect. Compound interest is why you have to closely monitor your spending with credit cards.
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What are the different types of credit cards?
To make things a little more complicated, not all credit cards are created equal. Here are a few of the most common cards:
- Unsecured Credit Cards – the most common type of credit card, which is typically available for people with fair to excellent credit.
- Secured Credit Cards – the first type of credit card many people get, as these cards are typically for people with no credit score or a low credit score. Secured credit cards typically require a security deposit which serves as the card holder’s credit limit.
- Balance Transfer Credit Cards – there are many credit cards which occasionally provide Balance Transfer Offers. Balance Transfer Options are presented to users at the signing of the credit card. At times, you may receive balance transfers throughout your time with your credit card. A balance transfer is, as its name implies, a transfer of a balance/debt from one credit card or credit product to another. Balance transfers are appealing as people can access lower interest rates after completing a balance transfer.
- Rewards Credit Cards – a very popular type of credit card which provides users with travel rewards, gas rewards, cash back rewards, or points. The points users earn can be used for a number of things. Points can be used for cash back, purchasing items through a points system, or travel. These rewards are provided to users based on pre-set criteria. Example: A user will receive 5 points for every $1 spent on travel expenses.
How do I choose a credit card?
Most people don’t analyze their credit card offers, which can be a dangerous gamble. Now, if you feel comfortable with gambling with your personal finances, you can always put your offers in a hat, shake it, and pick the first one that comes out. While we believe in meditation and understand the universe is a majestic place, we do not believe the card should choose you. If you’re reading this, we feel confident you’re not going to gamble with your personal finances and will prefer our simple advice.
When choosing the best credit card for you, pay close attention to the interest rate, reward options, early payment benefits, and balance transfer opportunities. To simplify it further, you want to do the following for the best credit card:
- Interest Rate = find the lowest rate available
- Reward Options = find the most valuable reward program!
- Early Payment Benefits = we love these!
- Balance Transfer Offers = the more the merrier!
If you need more help, a quick google search can provide you with reviews on credit cards you’re looking into or you can look into tools like NerdWallet’s credit card finder tools: https://www.nerdwallet.com/credit-cards
While owning a credit card, the name of the game is minimizing your interest rates. The way to keep your interest low is by not carrying a balance on your credit cards. While credit cards can be complex, having a credit card comes with its advantages. In many instances, people use credit cards to buy expensive items and pay them off over time. For example, many people will buy furniture, home appliances, or electronics with credit cards instead of using a loan, as loans sometimes come with early payment penalties and a number of other confusing terms. When comparing credit cards to money, it is far safer to carry credit cards. Credit cards allow you to easily track where your money is being spent. Most credit card providers offer fraud protection services to ensure strangers or thieves aren’t making unapproved purchases.
What’s a credit score?
A credit score is a three-digit number that defines how likely you are to repay debt. Your credit score is based on your history in using lines of credit. Banks and lenders use your credit score to decide whether they’ll approve you for a credit card or loan. Now, unlike the amount of debt you have, the higher your credit score, the better.
For most people, credit cards are the first step in building your credit score. Your credit score has a major impact on your eligibility for bigger loan products like mortgages, student loans, or automotive loans. Your credit score affects your eligibility for different loan products which may offer better benefits or interest rates based on your credit score. Credit cards are crucial in helping you build your credit score and are safer than money. Credit cards are also dangerous as your finances can easily spiral out of control. Some of the factors that impact your credit score include:
- Number of inquiries for different credit products – Low Impact
- Number of total credit accounts – Low Impact
- Age of Credit History – Medium Impact
- Number of Derogatory Marks – caused by missed payments, defaults, etc. – Medium Impact
- Percentage of Credit Card Utilization – High Impact
- Payment History – High Impact
Credit Cards Don’t Have to be Scary!
When used correctly, credit cards are actually a great tool. Aside from being able to buy things with ease, and build your credit, many cards provide you with the security to get your money back if for example your wallet gets stolen. Credit cards can help you book trips for free, with just the points you have accumulated without having to worry about paying the points back. Unfortunately, a lot can go wrong with improper use of credit cards that can take a toll of your quality of life and can really make you regret using one in the first place.
We know personal finance may not be an easy thing to grasp in a quick article. Schools do not have courses on personal finance, credit cards, interest, or money which leaves many people clueless when they finally get access to these tools. In our next article, we will dive deeper into interest and how it works. If all of this seems overwhelming, you are not alone. Yofii was founded to not only educate you but to help you get out of debt! We believe financial freedom should be accessible, and not exclusive to a small percentage of the population.
If you liked this article, leave a comment with what you learned. Let us know if this was helpful, and feel free to give us your feedback! Make sure to sign up for our newsletter to stay up to date on our great content! We will also update you on the release of our ebook “Imagine: Life Without Debt – A Guide to Financial Freedom.”