Frequently Asked Questions about Credit Cards

There is no one credit card that is the perfect choice for everyone.  The following questions and answers will help clear the air about the different types of cards available and explain how your own personal situation (income, debt load, credit score) influences the type of credit you will be approved for and which credit card is best for you.

How do I know which credit card is right for me?

It makes good financial sense to always consider carefully before applying for new credit.  For example, if you aren’t in the habit of paying off your existing cards in full each month you might want to think twice before taking on even more debt.

That being said, there are many different types of credit cards available to consumers.  If you consistently pay off your balances each month (thereby avoiding interest charges), a cash back rewards card might be a good option – you basically earn free money.  Or if you travel often and spend a lot on airline tickets and hotels, a travel rewards card might be the smart choice.

You should base your decision of what type of credit card to get after closely examining your own spending habits.  Does most of your money go towards groceries and gas each month?  Look for a card which offers a high rate of return on rewards in these categories.  Do restaurant expenditures account for a large portion of your monthly budget?  Again, search for rewards credit cards which give double or triple points on dining out purchases.

In short, carefully go over your budget and determine which credit card will allow you to earn the most benefits.  Whether you accumulate points, miles, or cash back, let your credit card work for you.

How does a credit card work?

Credit cards are the most common form of consumer credit in the U.S.  They can be a useful tool in managing your finances when used properly.  But mismanagement can quickly send you into a downward spiral of huge balances, excessive fees, and enormous interest charges.

Basically, credit cards allow you to borrow and spend up to a specified limit (your credit line).  Your lender determines your spending limit and also your interest rate.  These will vary according to your credit score, credit history, and income level.  The lender must provide you with the terms and conditions before asking you to commit (sign for) the credit card.

Each month you will receive an itemized statement showing what you have purchased on your card.  Most cards (but not all) have a grace period before interest will be charged on new purchases.  This is why paying your bill in full each month is so important. However, your statement will also show the “minimum amount due” to keep your account current.  Credit card statements now are required to show how long it will take you to pay off your balance if you continue to make only the minimum payment due plus the amount of interest you will be charged.

Always pay the full balance each month, if possible.  But most importantly, never miss a payment.  Just one late payment can trigger an automatic default to an extremely high APR (29% or more).  Remember, credit cards should never be used as a way to live beyond your means.  If you can’t afford to pay off your balance each month that’s a good indication your mishandling your credit card.

What if I am just establishing credit?  Or have bad credit?  What type of card is best-suited for situations such as these?

There are a lot of misconceptions about having bad credit.  Many people think they will never be able to get a credit card or any type of loan (car or personal) with a poor credit history.  However, this simply isn’t true.  While each person’s situation is unique, there are credit cards which specifically cater to people who have poor credit (Chapter 7 or Chapter 13 bankruptcies, for example).  These cards tend to have fairly low credit limits ($300 is typical) and very high interest rates (20%+APRs).  Additionally, they often charge an exorbitant annual fee- sometimes as high as $175.  As is the case with any type of credit card, you need to pay off your balance each month in full to not incur high interest fees.  A history of on-time payments, carrying little or no balances, and never exceeding your credit limit will slowly improve your credit score over time.

If you want to build (or improve) your credit, you might want to consider a secured credit card.  These types of cards are generally issued through banks and credit unions and require a deposit which matches your credit line.  For instance, when you deposit $500 into a savings account with the issuing bank you are given a credit card with a $500 credit line.  ($500 is fairly standard).  This deposit is used as collateral by the bank – your payments are not deducted from it.  This money is still yours as long as you don’t default on your credit card.  You should shop around for the best terms and conditions (as well as little or no fees).  Secured cards are reported each month to the credit bureaus (they are not identified as secured) so it is important to always make timely payments and keep a low (or zero) balance.

Most banks will continue to review your payment history and often will upgrade you to an unsecured card after a certain amount of time.  This can vary from six months to 2 years.  If and when this happens, your full deposit will be returned to you.

Does carrying a small balance each month on my credit card improve my credit score? 

This is a popular myth which is exactly that – a myth.  In reality, keeping a balance, no matter how small, does not help you build a credit score.  Paying less than the full balance every month can actually lower your credit score and is not a good idea for your overall financial well-being.

I hear so much about my credit score and how important it is.  How is it determined?

It’s smart to understand the importance of your FICO (Fair Isaac Corporation) credit score.  Knowing what affects it (good and bad) is key to ensuring that you make smart decisions when it comes to your credit- including the use of credit cards.  Here’s what determines your score:

  • Payment history – Do you pay your bills on time, every single month? It might surprise you to learn that this factor makes up 35% of your FICO score.  The importance of making consistent, on-time payments cannot be stressed enough.  The amount you pay has no bearing on this as long as you make at least the minimum payment.
  • Your overall debt load – This simply means how much you owe to all of your creditors. In this case, less is better and no debt is great. Your score is affected by the percentage of debt you have also.  If you have a credit card with a $2,000 credit limit and you owe $1,000- you’re using 50% of your credit.  If you have a credit card with a $10,000 limit and you owe $1,000- you’re only using 10% of your credit.  The total amount of what you owe comprises 30% of your FICO score.  The consensus is that you should only utilize 30% of your total available credit if possible.  Not carrying any balance is the best option.
  • Length of credit history – Creditors like to know that not only can you handle credit but that you can successfully manage your credit over a long period of time. This makes up 15% of your FICO score.  Keeping long-standing accounts will help boost your score.  This doesn’t mean you have to max out your credit cards.  Simply use them occasionally and pay them off in full each month.
  • Mix of credit – Paying off different types of debt shows that you can manage all types of credit. Car loans or installment loans can help your credit score if all of your other accounts are credit cards.  This factor accounts for only 10% of your FICO score.
  • New credit – Your credit score can take a small hit whenever you apply for new credit but it doesn’t usually last for long. New credit makes up 10% of your FICO score.

What else should I know about my credit score?

The cost of nearly every big purchase that you make is determined by your credit score.  Whether it’s a mortgage, a car loan, a credit card, or an installment loan- the annual percentage rate that you are charged will be calculated using your credit score.  The higher your score, the better terms you will receive.  Over the life of a mortgage or a car loan, this can result in huge savings on interest.  It’s important with credit cards also but if you pay off your balance each month – the APR doesn’t really matter.

If you want to rent an apartment or home, your prospective landlord will most likely check your credit score to determine that you are financially responsible.  Many employers also do credit checks before hiring new employees.

What’s a balance transfer?  Should I use one?

A balance transfer is literally what it sounds like – transferring an existing balance from one credit card to another.  Many credit cards offer balance transfers and some even have 0% introductory APRs for new cardholders – a great deal if you want to move a high-interest balance and pay no interest for however many months are included (6, 12, or 18 months are typical offers).  Be aware that most credit cards charge a balance transfer fee (even with 0% APR) which can range from $5-$10 per transfer or 3%-5% of the transfer amount- whichever is greater.

How do I opt out? I don’t want any more junk mail

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