How to Use a Credit Card the Right Way
Credit cards aren’t bad… as long as you don’t abuse them
Credit is a double-edged sword. Your credit cards allow you to make large purchases, take vacations with the family, and shop online. At the same time, using credit cards without a clear plan for managing the debt can lead to severe financial distress. If you want to be successful and financially stable, then you need to understand how to use credit cards in a way that’s good for your finances.
How to Use Credit Cards: The Basics
The Pros and Cons of Credit
With so many potential issues, it can be hard to remember that there are some upsides to using credit cards. On the other hand, it’s also vital to remember the downsides so you can protect your finances.
|You can buy needed items & cover emergency expenses||You pay more for purchases with interest added|
|There’s no need to carry cash||Additional fees may also apply to your transactions|
|It creates a record of your purchases||If you lose track of spending, you can face financial distress|
|It’s more convenient than writing checks and safer than carrying cash||There is a proven increase in the risk of buying on impulse|
|Some cards offer rewards with great incentives||“Purchase acceleration” can make you buy more just to earn rewards|
How to Use a Credit Card Step-by-Step
- First, you must apply for a credit card and get approved to use it.
- Credit approval usually depends on your credit score, although you can get secured credit with a small cash deposit.
- The credit card company extends a line of credit up to a certain limit that you can borrow against, as need.
- They also assign an interest rate to your account.
- Once you receive your card, you must activate it before you can use it. You usually call a toll-free number or activate it online.
- Then you can use the credit card to begin making purchases. There are two basic types of purchase transactions:
- “Card present” transactions mean you physically make a purchase by inserting your card into a card reader. You sign for the purchase.
- “Card not present” transactions mean you use the card number to make purchases online. You enter the account number, expiration date, and security code from the back of the card to authorize the purchase.
- Each month the credit card company sends you a bill, usually 20-30 days before your billing due date.
- The bill will tell you the minimum payment you must make by the due date.
- On or before the due date, you must pay at least the minimum amount due to avoid late fees.
- You can (and should) pay more than the minimum payment requirement.
- If you don’t pay the bill by the due date, penalties start to apply:
- Late fees apply immediately once you miss the due date.
- The credit card company will report the payment as missed if you are more than 30 days late.
- If you miss a payment by more than 60 days, the creditor will apply penalty APR.
Keeping up with minimum payments
Most common credit cards don’t require you to pay off the full balance every month. Instead, they require a monthly minimum payment. This amount changes depending on your creditworthiness, your credit limit, and your current balance.
If you only pay the minimum payment, the leftover balance starts accruing interest. This makes it easy to start racking up credit card debt. That’s right – minimum payments can be a trap!
Credit limits: Knowing when to stop
Your credit limit is a limit, not a goal. Using up too much of your line of credit is actually bad for your score and report. This is because it impacts your credit utilization ratio.
Calculate your utilization ratio yourself by dividing your total balances by your total credit limits on all your accounts. Is your ratio greater than 30%? That’s a sign you’re using too much of your credit limit.
Avoiding credit card fees
Credit card issuers already charge you interest. Don’t put up with fees, too! There are 5 common types to avoid:
- Annual fees
- Balance transfer fees
- Cash advance fees
- Foreign transaction fees
- Late fees
All of these extra charges are avoidable. Make sure you read the terms of agreement before opening a new card. You want to be aware of all of the possible fees associated with the account before it’s too late. Additionally, keep up with your payments to avoid the most common of the 5: late fees.
Good Habits for Using Credit Cards
When used correctly, credit cards are a useful tool to build credit. Each month, credit card companies report on consumer payments to the credit bureaus. If you always make your payments on time, you can quickly build good credit.
Aside from making your payments on time, here are some other good credit habits to develop:
- Always try to pay more than the minimum payment requirement.
- If possible, pay off your balance in full every month.
- Always review your monthly credit card statements to make sure you recognize all of the transactions; if you don’t, it could be a sign of identity theft.
- Call your credit card companies periodically to negotiate lower interest rates, particularly if your credit score has improved since you opened the account.
Risky Habits When Using Credit
Here are a few examples of bad habits that can lead to debt and credit problems:
- Relying on credit cards for daily purchases because you don’t have enough money in your budget.
- Using your cards without considering if you can pay the debt back.
- Making purchases that you know are outside of your budget because you really want those items now.
- Buying on impulse without thinking about it because your credit card is handy.
- Using credit cards to emergencies because you don’t have any savings.
- Only paying the minimum amounts due on your bills.
Choosing the Credit Cards for Your Needs
Not all credit cards are created equal. Understanding the different types of cards available can help you decide on the best card for you.
- Traditional General-Purpose Credit Cards. These are the most basic type of unsecured credit line available. You can purchase items up to a set credit limit. The credit card company applies a standard interest rate based on your credit score.
- Reward / Point Reward Credit Cards. These give you something back for making purchases, such as points to redeem for things like airline travel, groceries, and special events. You earn points for purchases and once you reach a certain level of points, you can exchange them. These credit cards always have higher interest rates than traditional cards!
- Cash Back Credit Cards. These give you a percentage of cash back for some or all of the purchases you make. You typically receive the money in a lump sum at the end of the year. Like rewards cards, these cards have higher interest rates.
- Secured Credit Cards. You can use these cards to build credit if you have bad credit or no credit. Simply put down a deposit with a creditor. The amount you put down (minus fees) will become your credit limit. You pay your bill as you would with any other credit card. However, if you fail to pay, the creditor can take your deposit.
- Store Credit Cards. These are cards issued a specific store. Retailers offer points and reward programs to store card users. These cards are usually easier to get with bad credit or no credit. Just be sure to read the terms carefully. Store cards tend to have higher rates and restrictive terms. For instance, some cards have deferred interest, which can lead to big bills and challenges down the road.
Important Factors for Comparing Cards
When you decide to get a new credit card, make sure you consider the following factors when comparing different credit cards you’re thinking of applying to use:
- Annual percentage rate (APR): Cards can have different APR for different types of transactions. Some cards also offer an introductory APR that only applies for a certain time. Also note the penalty APR that may be applied if you pay late, miss a payment or go over your credit limit.
- Fees / Finance charges: These include account setup and maintenance fees, charges for additional cards, as well as fees for various types of transactions.
- Payment schedule: Credit cards get paid back according to a set payment schedule that may differ from one card to the next. Some cards even require the balance to be paid-in-full every month. Know how payments are set so you can factor the payments into your budget.
- Terms for rewards/cash back incentives: Don’t just assume cards with rewards or cash back are better than traditional cards. The incentives may not be worth the extra cost in interest and fees. Do some calculations to make sure you wouldn’t be better off purchasing a reward in cash and using a traditional credit card with a lower interest rate.
Staying Up-to-Date on Your Terms
Thanks to new credit laws, major changes to your terms and conditions require 30 days notice prior to the change going into effect. The following list outlines the changes a credit card company must inform you about at least 30 days prior to it taking effect:
- A change in your credit limit
- An extension of your grace period
- A decrease in any charge, not related to a change in interest rate
- A change to any optional service on that account
- Any change in your interest rate as a result of a change in the reference rate
That last point can be confusing. This doesn’t mean a creditor calls to tell you when penalty APR has been applied to your account. They are only required to tell you if your APR changes because the reference rate used to calculate it changes; the reference rate is the base interest rate used to calculate APR.
Most credit cards follow the Federal Funds Rate from the Federal Reserve. This is the benchmark interest rate that determines the cost of borrowing for most consumer credit. When the economy is weak, the Fed lowers their rate to encourage people to borrow. This helps kickstart the economy. But when the economy is strong, the Fed raises the federal funds rate to combat inflation. This means using credit cards in a strong economy and carrying credit card debt is more expensive.
Outside of that situation, you may be surprised to look at a bill and see a different APR when didn’t know a new rate would be applied. If more than one rate is listed in your contract, it’s your responsibility to know when and how different rates apply.
How to Use Credit Cards Strategically without Risking Debt Problems
If you want credit to be a key element in your financial outlook that helps instead of hurts, you must use credit in a way that promotes financial stability.
So, for example, if you pull out the plastic to buy a couple of items at the mall because you’ve already spent your clothing budget for the month, that’s not a strategic use of credit. On the other hand, if you choose to put budgeted clothing purchases on a credit card because you’ll earn 5 percent cash back and then pay off the debt within the first billing cycle because the money was already allocated in your budget, then that’s smart.
With that in mind, you should really ask yourself two questions before you use a credit card:
- What benefit or advantage are you getting from putting the purchase on credit instead of paying for it in cash?
- How much more is that purchase going to cost with interest added before you finally pay it off?
These two questions can help you decide if it’s worth it to use your cards in the first place. They also help you plan what to do with the debt once it’s incurred. Ideally, credit purchases should give you an advantage without costing you in the long run.
But to reiterate, make sure to avoid behaviors that tend to get consumers in trouble with credit:
- Putting purchases on plastic because you’re short on cash.
- Using credit because you’re spending more than you should in a store.
- Using credit to pay bills or juggle your debts because you can’t afford all your payments in a given month.
- Spending on credit when you know you won’t be able to pay off the debt quickly before a lot of interest builds up.
Understanding interest rate grace periods
By law, every credit card has an assigned grace period set up in the billing cycle. Basically, if you start a month with a zero balance and then make purchases throughout the month, interest will only be applied if you do not pay off the balance in full before the end of the grace period. If you pay off the balance, then no interest gets added and you’re not paying anything extra for those purchases you made. As a result, you get the full benefit of any rewards you earn.
On the other hand, if you don’t pay off your balance in full before the grace period expires, then interest gets applied to that balance. But that’s not the worst of it – if you start a month with a balance, then the grace period doesn’t apply at all. So every purchase you make in the next month would have interest applied from Day One. Since reward credit cards tend to have high interest rates, the rewards you earn are almost always completely offset by applied interest.
With that in mind, the only way you really get the full benefit of the rewards you earn is by paying off your balance in full every single month. Otherwise, the rewards are offset by interest added – and the longer you allow your balances to carry over, the more interest you add.
An example of offset rewards using cash back
Cash back credit cards are fairly straightforward, so for the purposes of this explanation, we’ll use a cash back credit card to explain the issue you face with rewards being offset by interest added.
Let’s say you have a credit card where you earn 5% cash back on groceries and dining out. So you use this credit card to make all of your food purchases in a given month. Give or take, you spend about $300 a month on food for your family. So you earn about $15 cash back every month.
That’s great – especially if you’re being strategic and paying off the debt on that credit card in-full every month. You earn cash back on the food you’d be purchasing anyway, then put the money you have allocated in your budget for food to paying off this credit card every month. It’s the perfect system.
… Until you let a balance carry over from one month to the next, that is.
Let’s say money starts to get tight because you have a few unexpected emergencies come up. So you start making minimum payments on the card. Now interest gets applied to your balances. Even with a relatively low rewards APR of 15% you pay more than $3 every month in interest charges. In less than five payments, you completely offset the cash back rewards you earned. And that’s only if you stop charging on the card! If you make new charges every month, you’ll offset those rewards even faster!
Other types of reward credit cards are just as bad
If you think this balancing act only applies to cash-back credit cards, think again. Consider that the cash value of each mile you earn on a travel rewards credit card is only worth about $0.10-$0.15. Even if you have one of the newer travel miles credit cards that offers 2 miles for every $1 purchased, that’s still only a cash value of $0.20-$0.30.
Meanwhile, if 15% APR gets applied you’re looking at $0.15 in added interest for every $1 transacted. Of course, it’s a little harder to do the math, but point reward cards are no different when it comes to offsetting interest. Simply put, if you’re not paying off your balances in full at the end of every month, then you’re not really getting the benefit that you think you are using a rewards credit card.
Always opt for low APR on large purchases
With all of the above in mind, part of your credit card strategy needs to be tailored to ensuring you can pay off your rewards credit cards in-full without fail every month. This maximizes the benefits of using a rewards card at all.
At the same time, if you know that you have a purchase or series of purchases that you need to make that you won’t be able to pay off in full before the end of the month, then don’t bother putting that purchase on a rewards credit card – instead opt for your credit card with the lowest APR that you have. This means less interest gets applied each billing cycle as you attempt to pay off the debt.
Key questions for strategic credit card use
By using the above information to build your credit usage strategy, you can begin to use your cards in a strategic way that supports your financial stability instead of putting it at risk. Still, you may have some questions about how to use credit to your best advantage.
The following questions are four key topics you need to know if you really want to achieve mastery over your credit cards and the debt they generate:
- How do I choose the right credit cards for me?
In this section, we help you select your credit cards strategically so you can have accounts that help you achieve your financial goals and avoid problems with debt.
- How many credit cards do I need?
You may not know it, but having a low number of credit cards can actually make it harder to achieve the credit score you want. Learn how many accounts you need to have open in order to maximize your credit score.
- How much credit card debt is too much?
Having no credit card debt is ideal for financial stability, but if you really want to maximize your credit score, you shouldn’t actually maintain zero balances on all of your accounts. We help you find the sweet spot when it comes to credit card debt.
If interest charges are eating up your rewards and draining your budget, we can help. Talk to a certified credit counselor today for a free debt evaluation to find the right solution for your needs.