Most people seem to give credit cards a very bad wrap. It’s most likely because people tend to misuse them which is why they have such a bad reputation. If you understand how they work, how to use them, and are disciplined when using them, then they can be an extremely powerful tool to help you manage your monthly expenses, improve your credit score, and even earn some extra money.
How They Work
Credit cards are categorized as a revolving line of credit, which means you are allowed to have access to a certain amount of credit based on your approval from the credit card company that can be used and paid back down. What you put on that line of credit in a 30 day period will then either need to be paid back by the next due date, which is usually 15-20 days after the cycle ends, or you will end up paying a fairly high percentage interest on the balance that remains. The way this typically works is that at the end of the cycle, which is usually a set day each month, your balance on your credit card is calculated and a due date of roughly 15-20 days form that date is set for you to make a minimum payment in order to stay in good standing. The minimum payment is usually about 1 – 2% of the balance on your card. For instance, if you have $2,000 at the end of the cycle on your card, your minimum payment might be $40. If you paid just that $40 by the due date, the remaining $1960 would start collecting interest. Interest rates on credit cards can vary from around 8% up to double digits in the 20+%. Those are high rates you are going to have to pay on that remaining balance. This is where many people get into trouble. They start only paying the minimum payment. What happens is if you only pay the minimum payment, it will take a very long time to pay that balance back with that high of interest rate. A lot of times people get into more trouble because they may only pay the minimum payment, but then they use their credit line again and add to the balance. Now, they’re only paying the minimum payment, getting charged double digit interest, then adding to the balance that will get charged the double digit interest. Additionally, at some point if you are ever late on a payment, there are usually hefty late pay penalties that get added to that balance as well. This is how things can get out of hand very quickly for a lot of people who don’t use credit cards properly. If you are able to keep your balance on your credit card in check, or within your budget, and you pay the full balance off each month, you don’t owe any interest. Actually you were able to create a window where you used your credit card on your monthly expenses and were given roughly 15-20 days to pay it off with no interest. If used wisely, credit cards can be a very powerful financial tool.
Benefits of Credit Cards
One of the biggest things that credit cards can do for you is build your credit score up, again, if they are used wisely. When I was 18, before I went to college, I applied for a student credit card. I think it only had a $300 limit on it. I would use my credit card only for gas and food. Each month I would pay it off. I did this all through college. When I graduated college and went to get my first loan, I had a credit score built up over 700 which helped me get a much better rate on my loan and I didn’t have to get a co-signer on that loan. Another trick you can do to help your kids out before they’re 18 is you can add them as an additional signer on your credit card. They don’t even have to use the card, just be listed as an additional signer, which basically lets them piggy back off of your credit history from that card. Then when you think they’re ready to start using the card, you can let them try it out for themselves. If credit cards are used wisely, they can be the best credit building tool for young people right out of the gate. This helps them get started out a step ahead. By already having a good credit score, they will be able to get loans easier, better rates on loans, be able to put things in their names without a cosigner, and save a ton of money in the loan run.
Rewards are another great perk to using credit cards. There are so many cards to choose from now, you just have to try to do some research to see which one would be the best fit for your spending habits. Some offer cash back based on where you spend your money each month. For instance, they may give you 2% back on gas or groceries, and 1% back on anything else. Some cards have airline perks that give you flyer miles to go towards your plane tickets. Of course, if you don’t travel or fly much, these cards are of no benefit to you. Some cards are themed to be used at specific places or websites. For instance, Amazon has a Prime card that gives you points on anything you spend to be redeemed on your Amazon purchases. If you can use your card wisely, pay the balance off each month, then you actually get rewarded to do so by these credit card companies. I want to offer a quick warning on rewards. Do not spend money just to get rewards. You will end up overspending on things you don’t need and you may put your finances at risk by doing so. Rewards should just be a perk for planned and disciplined spending habits.
Another great benefit to credit cards, is the 0% offers. You can find some cards that will offer you 0% for so many months when you sign up for those cards. I think this can be of great benefit when you have a decent sized purchase you need to make whether it’s a major home repair or a vacation. Basically, you are given a certain number of months to pay it back without any interest being charged. Again, this is a great tool if you use it wisely. Don’t go buy a bunch of things you don’t need just because you have 0% interest for a while. Use it for bigger ticket things that can help you maintain your monthly budget. Even after the initial 0% interest period is over, a lot of these credit card companies will offer it to you later down the road as a special offer again. I get these offers all the time with my cards and I use them when they come up.
Best Practices for Credit Cards
The best way to use credit cards is to know your monthly budget and only put on the credit card certain types of items in your monthly budget. For instance, use them for groceries, gas, and maybe for your discretionary spending. You should already have a monthly budget amount for those types of items, so you can keep an eye on how much you’re spending as you go through the month. Most cards have a way for you to categorize your spending when you logon to the site or app to help you keep track of where you are spending your money. This may actually be an easier way for you to help monitor you monthly spending. You may also find it better to put items you need more help tracking on the credit card since it is separate from your bank account. Most people tend to set up fixed payments like their rent or mortgage, and car payments from their bank accounts. By using a credit card, you can keep those variable costs separate from your fixed costs to help give you a better idea of where you are spending your money each month.
I just want to reiterate that credit cards are not for everyone. It does take some discipline and planning to use them properly. If you don’t have a monthly budget planned out, credit cards may not be a good option for you. If you are trying to get yourself on the right track and are planning your budget, I would practice your budget for a few months first to make sure your numbers are good, then you can look at incorporating credit cards to help you monitor and mange your monthly expenses, plus earn some extra money with those rewards.