So, You Want to Get a Credit Card?
Signing up for your first credit card can feel like a scary endeavor. A quick search into the downfalls of having a credit card can take you down a very dark rabbit hole of financial horror stories, which will undoubtedly have you running the other way screaming. If you somehow can look past these stories and have decided you need to get a credit card (which you do), the next hurdle is wading through the THOUSANDS of options you have when it comes to credit cards. Fees, points, perks, affiliated with a brand you like; the options can leave you drowning in comparisons making you stagnant and indecisive. All of these items above are certainly worthy of consideration, but the most important thing you can do is pick one and go so you can get started on your credit-building journey. If you can’t decide on which card to get, find one with no fees and a point or cash back system and move on, you can correct course down the road with no damage done.
Why You Need a credit Card
Earlier I mentioned that you definitively need a credit card, and here’s a high level overview of why. If you’ve been in the market, or plan to someday be in the market, for any of the major life purchases (car, house, business loan, student loan, etc.) you have/will come head on with the topic of your credit score. Credit scores are based on a 300-850 point range (see image below). A good credit score can save you thousands of dollars over the course of a lifetime when it comes to major life purchases. Why? Simply put, your credit score is the statistic banks or other money lenders look at to determine how much of a financial risk it is to loan you the money to make your big purchase. A bad credit score can mean severely unfavorable interest rates, which over the course of a 5-7 year car loan or 30 year mortgage for your house, can quite literally add up to thousands or even tens of thousands more in interest payments! Credit cards are one of the main factors that make up your credit score, and when used properly can help you build and improve your credit score. Things like available credit to debt ratio, on-time payment history, and years of credit history are the most critical aspects of how owning a credit card can impact your credit score. The duration of your credit history is the one aspect you have the least control over, which again is why it is important to just pick a conservative one as described above and start building credit. Next, we’ll cover the rules of owning a credit card so you are using it as a positive financial tool rather than ending up in a financial horror movie.
Rules for Owning a Credit Card
Credit cards are essentially free short-term loans, when used properly. When used incorrectly, they can cost you between 16-25% more for every purchase you make on the credit card. When you sign up for a credit card, the issuer will also be looking at your credit score and credit history, and will likely start you out with a very conservative credit limit (maybe as low as $500). Most times this is unavoidable, so we need to follow the rules that will be laid out next to increase that limit, which in turn will boost your overall credit score.
Rule #1: First and foremost, and I cannot stress this enough, never EVER miss a credit card payment. Average interest rates on credit cards typically fall in the range of 16-25%, so missing a payment will cost you significantly. These high interest rates are how people end up in the horror stories you read about because once you miss a payment and get hit with the interest at months’ end, it makes it that much harder to make next month’s payment in full, resulting in another round of interest hitting you! On top of that, on-time payment history, as mentioned earlier, is a major factor to your credit score. As unfair as it sounds, one missed payment can drop your credit score 50-100 points! To put that in perspective, we’re talking about a credit score system that ranges from 300-850, so a 100 point drop is significant to say the least. So again, pay off your card in full every single month, no exceptions.
Rule #2: Pay off your credit card in full every month! That’s right, it’s so important that it’s rule #1 and #2. One way to guarantee this happens is to automate your credit card payments. If you set up auto payments and make sure you are not spending more in a given month than you will be able to pay at the end of each month you will be on your way to credit euphoria.
Rule #3: Increase your credit limit regularly. Assuming you have followed rule #1 and #2 to a tee, this should be an easy task. Every 6-12 months call up your bank and request an increase in your credit limit, even if you don’t need the extra money. Tell them you have a not missed a payment in the last __ months and you would like your limit increased. Some banks will do this without you even requesting to have it increased, but if not make certain you are proactive and call them. The reason behind this move is the available credit:debt ratio mentioned earlier relating to your credit score. If you’re stuck at that $500 credit limit and spend $500 per month on it regularly that gives you a 100% credit:debt ratio which is not good in the eyes of the credit bureaus. You want to have as low of a credit:debt ratio as possible while actively using your card. DO NOT use this increased limit as a reason to spend beyond your means, as that would defeat the purpose entirely. In the scenario above, if you had your credit limit increased to $1,000 and continued to spend $500 max per month, your credit:debt ratio would be 50%, which will go a long way in boosting that credit score of yours.
Use the Perks
We’ll cover the detailed perks of credit cards individually in a later article, but for the basis of this intro to credit cards we will keep it simple. Almost every card these days comes with perks or point systems, which are complicated ways of saying FREE MONEY! Some credit cards come with up to 6% cash back on your purchases, and again this is nothing but free money. When you consider the average returns on the S&P 500 over the course of the last 30 years being 8%, earning 6% back just for buying things you would purchase regardless is significant. Make sure you are taking full advantage of the perks and points system your credit card offers. If you aren’t sure the full extent of the perks (there are some incredible perks in the fine print), call your bank and ask them to outline all of the perks of the card. You may be surprised to learn things like you never need to purchase rental insurance when renting a car because many credit cards come with free rental car coverage. That’s just one example of the variety of perks offered by various cards, so take 15 minutes to understand what perks you have and then use them!