How Credit Cards Work
Credit cards allow us to make purchases and pay for them later. They can be extremely useful financial tools when used responsibly. At Delancey Street, we want to help consumers develop healthy relationships with credit. This article will explain exactly how credit cards work and provide tips for using them wisely.
A credit card is a type of loan. The credit card company loans you money to make purchases, and you agree to pay back the money later.When you use your credit card to make a purchase, you are borrowing money from the credit card company. You will receive a bill at the end of each billing cycle (usually monthly) that tells you how much you owe. You must make at least the minimum payment by the due date.If you pay your entire balance by the due date, you won’t owe any interest. If you don’t pay the full balance, interest will be charged on the remaining amount. Credit cards typically have high interest rates, so it’s important to avoid paying interest if possible.
One of the main benefits of using a credit card responsibly is that it can help build your credit score. Your credit score is a number that tells lenders how risky or safe you are as a borrower.When you make on-time payments every month, it shows lenders that you can handle credit responsibly. This will improve your credit score over time. Having a good credit score makes it easier to get approved for loans and other credit in the future.
Rewards and Benefits
Many credit cards offer rewards programs and other benefits. For example, you may earn 1-5% cash back on purchases or points/miles that can be redeemed for travel. Credit cards may also include benefits like rental car insurance, extended warranties, and purchase protection.Rewards cards incentivize you to use your credit card more frequently. But it’s important not to spend more just to earn rewards. Only make purchases you can truly afford to pay off.
Credit Limits and Utilization
When you open a credit card, you will be assigned a credit limit – the maximum amount you can borrow. It’s important to keep your credit utilization low. Credit utilization is the percentage of your total credit limit that you’re using.For example, if your limit is $1,000 and your balance is $500, your utilization rate is 50%. Experts recommend keeping utilization below 30%. High utilization hurts your credit score.
You will receive a billing statement each month that shows your balance and minimum payment due. The minimum payment is typically 2-3% of your balance. But you should always try to pay more than the minimum if possible.Paying just the minimum causes interest to accumulate and it will take a very long time to pay off the balance. It’s better to pay in full each month if you can. At the very least, pay more than the minimum to pay off your balance faster.You can pay by check, on your credit card company’s website, over the phone, or by setting up automatic payments. Make sure to pay by the due date to avoid late fees.
Common Mistakes to Avoid
- Paying late – This will result in late fees and hurt your credit. Set up reminders to help you pay on time.
- Maxing out your credit limit – Try to keep utilization under 30% of the limit.
- Applying for too many cards – Each application causes a hard inquiry on your credit report which can lower your score temporarily. Only open accounts you actually need.
- Paying only the minimum – Pay more than the minimum whenever possible to reduce interest charges.
- Not reviewing your statement – Check transactions regularly to make sure there is no fraudulent activity or billing errors.
- Forgetting to pay an annual fee – Some cards charge annual fees. Be aware of these fees when signing up for cards.
Tips for Responsible Use
- Pay your balance in full each month to avoid interest charges.
- Set a budget and only charge what you can afford.
- Review statements regularly and report any errors immediately.
- Pay more than the minimum payment whenever possible.
- Set up alerts to help you monitor activity and ensure on-time payments.
- Take advantage of rewards but don’t overspend just to earn them.
- Shop around and compare cards to find the best fit. Consider fees, rates, and rewards.
- Keep cards open and active to build credit history. Don’t close accounts unless necessary.
Alternatives to Credit Cards
Credit cards aren’t for everyone. Other options include:
- Secured credit cards – Require a security deposit and help build credit.
- Debit cards – Deduct purchases directly from your checking account.
- Prepaid cards – Load funds to the card and spend up to that amount.
- Cash/Check – Avoid interest and debt by only spending the cash you have on hand.
The Bottom Line
Credit cards can be very useful when used properly. But they come with risks. Follow the tips in this guide and always make payments on time and in full when possible. Don’t spend more than you can afford to pay back. If you use credit cards responsibly, they can help you build your credit score and even earn great rewards!