What Is a Credit Card?

A credit card allows you to borrow money from your bank to make your purchases, whether you’re buying a burger or a round-trip ticket to France. As long as you pay back the money you borrowed within the “grace period” of 25-30 days, you don’t have to pay extra. If you don’t pay it back in that time period, you’ll have to pay interest — a percentage of the money you owe the bank — on top of what you borrowed.

Credit card pros and cons

Choosing a credit card

When you’re deciding which credit card to get, ask yourself one question: Will I need to pay interest on my debts?

If you pay back everything you spent on time, you can get a credit card with rewards. These cards give you points, cash or airline miles every time you use them. However, if you do use a rewards card, you’ll have a very high interest rate. That brings us to what to do if you do carry a balance (in other words, you don’t pay off your debt every month). You’ll want to minimize your interest payments, so you should pick a credit card that has a very low interest rate.

Your credit card is issued by a bank, like Bank of America or Chase. The bank determines your interest rate, fees and rewards, so it’s important to find a bank that offers a card you like. It’s processed on a network, like Visa or MasterCard. The network doesn’t really affect the card, except for giving you random perks like travel accident insurance. Generally, the network isn’t as important as the bank.

Interest payments and fees

Credit card companies make money in three ways:

  • Interchange fees, or fees charged to the merchant every time you use your credit card
  • Interest payments, from when you don’t pay off your debt in full
  • Fees. like late payment or annual fees

You don’t have to worry about that first one. Interchange fees are a problem for merchants. Instead, concern yourself with interest payments and fees.

If you have a rewards credit card, remember that issuers don’t give those points out of the goodness of their hearts. Most people think they’ll earn more in rewards than they pay in interest, but that’s rarely the case. If you think there’s a chance you won’t pay off your balance every month, steer clear of rewards.

Credit cards charge a number of fees, from an annual fee to cash advance fees to late payment fees. Your card probably won’t have an annual fee, but make sure to make at least the minimum monthly payment on time, or you’ll be slapped with a fee, a higher interest rate and/or a lower credit score.

Reading the fees

Credit card applications always come with what’s known as a Schumer box: a black-and-white box that tells you the most important information about the card. Here’s a breakdown of how to read the Schumer box.

  1. APR for purchases. This is your interest rate that will be charged on anything you didn’t pay off the month before. The APR is the monthly interest charge multiplied by 12, so every month, you’ll be charged 1% of the amount you owe. On some cards, you won’t be charged interest for the first six months or so, allowing you to make a big purchase and pay it off over time interest free.
    1. Variable APR. This means that your interest rate may change based on a nationally set base rate called the prime rate. In this case, your interest rate may not

      always be X. If the prime rate rises 1%, your interest rate does too.

  2. APR for transfers. If you have credit card debt, you can shift it over to a new card. Some cards will let you shift your debt and not pay interest for 6 to 12 months, but others will charge you the same rate as regular purchases.
  3. APR for cash advances. If you take out a cash advance (you withdraw cash from an ATM or get money from a bank teller), you’ll be charged this interest rate on the amount you borrow. Unlike regular purchases, where you have a grace period to pay off your debt, you start accumulating interest on cash advances the day you take them out.
  4. Penalty APR. If you miss a payment, you may have to pay this interest rate for up to six months.
  5. Avoid paying interest. This tells you your grace period, or how long you have after receiving your credit card statement to pay off your debt without accruing interest.
  6. Minimum interest charge. If you owe $1 and your interest rate is 12.99%, you’d normally be charged $0.01, but the credit card company will bump it up to $0.50 anyway.
  7. Annual fee. Exactly what it sounds like. Most student and youth credit cards don’t have an annual fee.
  8. Transaction fees
    • Transfer fee: If you move your credit card debt from one card to another, you’ll be charged this fee on the amount you move once and only once.
    • Cash advance fee: If you take out a cash advance, in addition to accumulating interest the day you take it out, you’ll have to pay this fee.
    • Foreign transaction fee: If you use your credit card overseas, you’ll be charged this fee on the amount that you spend abroad.
  9. Penalty fees
    • Late payment: If you don’t make the minimum payment within the grace period, you’ll have to pay this fee.
    • Over-the-limit: Sometimes, your credit card will let you go over your credit limit (the issuer can also choose not to). If it does, you’ll have to pay this fee.
    • Returned payment: If you try to pay your credit card bill and it doesn’t work for some reason (like the check bounces), you’ll have to pay this fee.
  10. Rewards program details. If you have a rewards credit card, this portion will spell out exactly how you can earn and redeem your rewards. Read this section. It’s where a lot of cards try to game you.

Knowing how your balance is calculated

Most credit card companies calculate your balance based on average daily balance. Let’s say you didn’t pay off $100 during the 30-day grace period. On day 15, you pay off the entire balance. You add up the debt that you had left over at the end of the day (15 days of $100 + 15 days of $0) and divide it by the number of days. You’ll be charged interest on $50.

NerdWallet tips

  • Choose a credit card that’s optimal for your needs. If you carry a balance, you can find great credit cards that specialize in low interest rates or 0% APR periods. If you don’t, you can ignore the APR and shoot for high rewards.
  • Remember that you’ll need a co-signer on your card even after you’re 21 unless you have your own source of income.
  • Having a credit card is better than not having one, but not having a credit card is much better than misusing one.

Source: www.nerdwallet.com

Category: Credit

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