The Low Down on Credit Cards
THE LOW DOWN ON CREDIT CARDS
How Do They Work?
When you buy something with a credit card, you’re basically buying it with a short-term, no money deposit loan. You get instant approval as long as whatever you’re purchasing is below your credit limit. A debit card on the other hand, only allows you to purchase things if your bank account has enough money to cover the entire cost.
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The Dangers of Credit Cards
Before I go into the details of why credit cards are so great, I’ll start off with reasons why they can be so dangerous.
(1) Scary High Interest Rates
These mini loans can be scary expensive. The average interest rates for credit cards range from 15%-20%+, in other words, credit cards have CRAZY high interest rates compared to other types of loans like home, car, and student loans which usually have interest rates in the 3%-11% range. Note, you only need to pay interest if you do NOT pay the full monthly credit card balance. Usually credit cards give you this dangerous option of paying a minimum monthly balance, which is typically something like $25-$35/month. You might say, “Uh Angela, $25-$35/month minimum payments for credit card balances that are potentially in the thousands sounds like a steal to me!” Yeah, I mean it WOULD be a great deal if there wasn’t any interest, or more specifically COMPOUNDING interest (aka paying interest on built up interest). If the balance is high enough, only paying the monthly minimum can mean you never get to payoff the balance and instead, having that balance grow every month. Below is an example of how interest can screw you quickly:
Example: You buy a $1,000 laptop with your 17% interest credit card, only pay the monthly minimum of $25/month and buy nothing else with the credit card
Time it takes to pay off that initial $1,000: 5 FREAKING YEARS
Money spent on just interest: $486.20
Total amount you paid back: $1,486.20
In the above example you almost end up paying 50% MORE than what you initially spent because of interest! THAT’S A YIKES FOR ME. As you can see from this example, if you’re not careful, you can find yourself DROWNING in a sea of what initially seems like a small loan.
You can use online calculators like this to calculate payoff timelines.
Note: Typically credit cards compound daily, but for simplicity I used monthly compounding
(2) Risk to Your Credit Score
If you find yourself starting to miss credit card payments or worse, defaulting on your credit card(s) your credit score will take a hit. Having a bad credit score and delinquencies on your credit report can mean that you may no longer qualify for other credit cards and loans. Even if you can still qualify for loans, you may not qualify for good rate terms due to your poor credit score. Also, some landlords/apartments pull your credit report to see if you’ll most likely be a reliable tenant. A bad credit score shows that your may not be financially responsible and your application can be denied even if you make a decent income.
Pro-Tip: You can request FREE copies of your credit report every 12 months from www.annualcreditreport.com. There are 3 credit bureaus (Equifax, Transunion, & Experian) so I recommend requesting your free credit report from different credit bureaus every 4 months. For example in January you can order from Equifax, in April you can order from Transunion, and in August you can order from Experian. Then start again the following year.
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The Benefits of Credit Cards
(1) Improving Your Credit Score
Yes, credit cards can hurt your credit score but they can also help build your credit as well, if used responsibly! Prior to opening my very first credit card, I didn’t even have a credit score and now my score is in the excellent range (720+ score). As I briefly mentioned before, you need a good credit score to qualify for better credit cards, car loans, home mortgages, and sometimes even rentals. Great credit is what qualifies you for better rates that can save you lots of money since it shows people/lenders that you’ve been responsibly paying off your debts and are not likely to default on them.
Quick PSA – PLEASEEE don’t take out any unnecessary loans to try and improve your credit score. Paying interest on a loan you don’t actually need? – YEAH THAT’S A NO GO FOR ME.
(2) Cash From Sign On Bonuses
Many credit cards have worthwhile sign-on bonuses that give you money, I’m talkin CASH, for opening a new credit card or spending $X amount by X time. These sign on bonuses can range from $50 – $500+.
One thing to be careful of is to NOT spend more money than you usually do just to get these bonuses. For example, if you typically only spend $1k/month on card related expenses please don’t start spending $2K+/month just to get credit card bonuses. You can easily end up losing more money than what you get from these credit card bonuses. What you CAN do is spend money strategically. Maybe you’re about to make a big move that will temporarily increase your spending or you’re planning a vacation. You can open your credit card around this time to cash in on that bonus responsibly.
(3) Credit Card Points
Who says that the money stops at the opening of a new credit card? You can continue to keep on keepin’ on with credit card points! There’s a ton of credit cards that give you credit card points for using them which you can then use to get cash back, buy plane tickets, book hotel rooms, redeem for gift cards, lower credit card bills, etc. I remember one of my friends complaining that her credit card points were so small, to which I said, the best kind of money is free! Also, not all credit cards are created equally, some give no points and others give 2-5X for certain categories (traveling, groceries, gas, etc.). My favorite way to use credit card points is to buy discounted plane tickets. I’ve probably bought a couple thousands of dollars worth of plane tickets with my credit card points over the last few years.
(4) Fraud Protection
The Fair Credit Billing Act (FCBA) gives credit users heavy protection against fraud. If your credit card somehow gets stolen or the credit card numbers get compromised, due to the FCBA the maximum you would be liable for is $50, but in most cases it’s $0. I’ve actually had my credit cards compromised a few times over the years and while the bad guy got away with sometimes $100s of stuff I wasn’t charged for any of it. Also, the credit reversal time period was within a few days. Credit cards can also protect you from shady merchants. Say you booked an Airbnb but turns out that place was rat infested so you couldn’t stay there but for whatever reason Airbnb was not willing to reimburse you. Well, you can actually let your credit card provider know and they can initiate a chargeback, which essentially reverses the credit card charge that was made so you can still get your refund. This can also work with businesses that sell you items online as well. I recommend trying to reach out to the merchant first before trying to initiate a chargeback and remember to document EVERYTHING. If nothing works out, going through the chargeback process.
Unfortunately since debit cards are directly linked to a bank account they’re not protected under FCBA but under the Electronic Fund Transfer Act (EFTA). The EFTA isn’t as forgiving. For example, if you end up reporting fraudulent charges more than 48 hrs after you learn about it you may be on hook for $500+ of the charges – that’s a yikes
(5) TEMPORARY No Interest Mini Loans
No interest? Wait whatttt…. Angela you just told me about the absurdly high interest rates that credit cards have! Relaxxx, yes I said that because it’s for the most part still correct. However*** there are special credit cards that offer 0% interest rates for a LIMITED time (usually 12 – 18 months). Basically, for that LIMITED time offer, you don’t have to pay for any credit card interest. These types of credit cards are great for things that pop up unexpectedly but you don’t have the funds right now to cover all at once. For example, maybe you got a new job offer that requires a big move but the company offers little to no moving bonus or you’re in between jobs and are really tight with funds. Hopefully in the future you’re able to build up an emergency fund for these kinds of situations but right now you need a quick solution….and for sure will heed Angela’s advice to start saving for that emergency fund in the near future. Anyways, what’s important to remember now is that once the interest free window is up, most likely your new interest rate will be somewhere in that 15-25%+ range so before that time’s up, you should make a plan to payoff that entire credit card balance. Usually a reasonable monthly payoff plan is the easiest way to go!
(6) Miscellaneous Benefits
Remember, not all credit cards are created equally. There’s a number of other benefits that different credit cards offer such as: waived foreign transaction fees (aka no fee when using your credit card abroad), automatic rental car insurance, free towing services, travel protection, airport lounge access, purchase protection, etc. Some credit cards are “free” with no annual fee while bougie ones can cost $100+ per year. Do your research before opening up any credit cards!
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General Credit Card Rules
(1) Don’t spend money you don’t have. Yes, there are times where you may find yourself in a desperate situation and need to break this rule BUT if you find yourself wanting to impulsively buying unnecessary things you can’t afford, just don’t. If you really want it, save up for it or buy it used!
(2) Don’t overspend JUST for bonuses/points! That’s like spending $500 for a $250 or less gift card… Strategically buying/paying for things that were already planned for is fine but again, if you don’t typically spend $4k in 3 months don’t go do that for a sign on bonus.
(3) Pay off the full balance every month! Remember, credit card interest can be brutal and a seemingly not so large amount can end up taking a long time to completely payoff due to interest. Don’t be satisfied with just making minimum payments if you can help it!
(4) Keep your credit card utilization low, below 30%! Utilization is how much of your total credit limit you’ve used. So if your total credit limit is $1,000 you should keep your credit card balance below $300 at all times. For adults, the $300 limit is fairly low and if this is the case for you, use the following methods to keep a healthy utilization rate:
- Payoff your credit card weekly/more frequently than just once a month. Typically your credit score is based off of a snapshot in time so even if you overall spent more than 30% of your credit limit in the month, if you prematurely payoff all/part of your balance to always keep the balance below 30% you should be gooood.
- A better long term solution is to request higher credit limits from your credit card provider. This is especially a good idea if you initially got your credit card as a college student and have since graduated and make a full-time income. The credit card company may raise your credit limit several thousands of dollars
- Upgrade/get a new credit card. I was able to increase my credit card limit from $300 to $30K+ over the course of a few years by upgrading my credit cards. If your income improved significantly and your credit score is now great or dare I say, excellent then you may want to shop around for a new card that checks off more of what you want from a card. I started off with a pretty terrible, no point earning card because that’s all I could get approved of, but since then I’ve upgraded a few times and now hold a much more lucrative card with tons of benefits.
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BONUS: For that Credit Card Sinner Who Kind of Messed Up
Alright so some of you may have found yourselves in a credit card pickle due to financial irresponsibility or maybe something unexpected happened and you didn’t know about those sweet 0% interest credit cards. Bottom line, you are now suffocating in some serious credit card debt – well, I got some good news for you. There are many credit cards that offer something called a balance transfer. A balance transfer allows you to transfer the balance of your credit card to another credit card – perhaps a credit card with better terms than your current credit card. Yep that’s right, you can transfer your credit card debt with that crazy high interest to another credit card that temporarily offers you 0% interest! Many credit cards charge some kind of fee for a balance transfer (usually something like the greater of $5 or 3-5% of the transfer balance). But through limited research I found that the Chase Slate card allows free transfers if it’s done within 60 days of you opening the card (afterwards it’s 5% of the transferred balance) and 0% interest for the first 15 months (As of 12/6/2019 – please confirm prior to opening any new credit card). Do your own research though because it may be worth it to pay for transfer fees for a longer 0% interest period. Again, BE AWARE, once that trial period is up the interest rate will most likely be even higher than average credit card rates so please be responsible!
Thanks for reading my post! Just a reminder I am NOT a certified financial advisor/professional. I just write these posts for fun! Please do your own research before doing anything big.
**Disclaimer: I am not a licensed financial advisor nor planner nor a certified financial analyst nor an economist nor a CPA nor an accountant nor a lawyer. I’m not a finance professional through formal education. You should always verify everything before making any decisions.