You’ve heard the stories of people who have visited six continents for free, all while flying first class. Asked how they do it, they explain their formula of opening a bazillion credit cards a year while mastering the voodoo calculus behind bonus miles and rewards points. Then you’ve likely heard the cautionary tales of people who trace their six-figure credit card debt to the first time they decided to carry over their balance “just this once.” For most people in the U.S., credit card usage falls somewhere between these two extremes. The average American held 3.1 credit cards in 2017 and carried a total balance of $6,354, according to Experian’s eighth annual State of Credit survey. Here’s the truth about credit cards: Most of us will probably never achieve miles-and-points jet-setter status. And if you tread carefully, you can most likely avoid plunging into a black hole of credit card debt. But avoiding credit cards altogether can make life really difficult. Without a credit card, you could have trouble booking a hotel room or renting a car. Plus, a credit card is often your first chance to show lenders you can manage debt responsibly. Getting financing for a major purchase, such as a home or car, will be harder if you’ve never had a credit card. TPH Academy’s Credit Cards 101 is your starting point if you want to learn how to use credit cards responsibly. We’ll teach you the things credit card companies don’t want you to know, like how they make money and the sneaky language they put in the fine print. Whether you’re new to credit cards or you’ve been using them for decades, we’ll teach you how to use them to your financial advantage. What you won’t find in this course is a guide gaming the points system like a pro. (Hey, remember: This is Credit Cards 101, right?) We hope this course will empower you by showing you what really happens when you use your card. Ready to change the way you look at the plastic in your wallet forever?
Some of the links in this document are from our sponsors.
- Payment network: If you have a credit or debit card, there’s a good chance it has the Visa or Mastercard logo. But Visa and Mastercard don’t actually issue credit cards. They’re payment networks, which means they facilitate the payment between you and your bank, and the merchant you’re paying. (Note: Discover and American Express issue credit cards and function as payment networks.)
- Issuing bank: The bank that approved you for your line of credit that you make your payment to. This bank determines your credit limit and how much you pay in interest.
- Card number: This number is typically 16 digits and identifies both the card issuer and the borrower. It’s not the same as your account number, which you can find on your credit card statement.
- Card holder: The person the card belongs to. They can be the account’s owner or someone the account owner has authorized to use their line of credit.
- Expiration date: You have until this date to replace your card. But even if your card expires, your account doesn’t. So be sure to contact your issuing bank if you want to close the card.
- EMV chip: This tiny computer chip makes it harder for thieves to steal your data by creating a unique code for each transaction.
- Card verification value (CVV) number: This is a three- or four-digit number that’s used to confirm you have physical possession of a card when you’re making a purchase online or by phone.
- Magnetic stripe: This is encrypted with information such as the cardholder’s name, the card number and the expiration date. Newer cards that have an EMV chip don’t need to have a magnetic stripe.
- Bank contact info: This can come in handy if you need to report fraudulent activity or request changes to your credit agreement.
02 How Credit Cards Work
When you were a kid, credit cards probably seemed like a magical tool your parents kept in their wallets to avoid spending money. Of course, as you got older, you realized that you actually have to pay back that money — plus interest in most cases.
When you’re approved for a credit card, you get a line of credit that you can use to make purchases up to a certain limit. When you make a purchase, your line of credit decreases by the amount you charge, whereas when you make a payment, your available balance goes up by the amount you pay.
A line of credit is a type of revolving credit, which means you can carry your balance from one month to the next. There’s no end date by which you have to pay off the balance.
Loans, by contrast, have a fixed repayment schedule. They offer installment credit, meaning that you borrow a fixed sum of money and pay down what you borrow in monthly installments that consist of the principal (the amount you borrowed) and interest (the amount you pay to borrow money).
HOW DO CREDIT CARD COMPANIES MAKE MONEY?
Banks make money off credit cards in three main ways:
- Interest charged to borrowers: The yearly fee you pay for borrowing money is usually advertised as an annual percentage rate (APR). As of November 2018, the average APR for credit cards was 17.14%, according to CreditCards.com.
- Fees charged to borrowers: You pay fees for going over your credit limit or missing a payment. Some credit cards charge annual fees. There are also cash advance fees, balance-transfer fees, foreign transaction fees… So. Many. Fees. (We’ll explain many of these later.)
- Interchange fees charged to merchants: When you use your card, merchants pay a processing fee of about 1% to 3% of your purchase.
Of these, interest is by far the biggest revenue generator for credit card companies.
HOW DOES INTEREST WORK?
Suppose you buy a new refrigerator for $1,000 using a card with an 18% APR.
You’ll get your bill at the end of your billing cycle, which is usually about a month. Your payment will typically be due at least 21 days after the end of your previous billing cycle. For most credit cards, the time between when you get your statement and the payment due date is what’s called a grace period. Pay off your balance in full by the due date, and you’ll usually avoid interest. (Warning: Credit cards aren’t required to offer a grace period, so read the fine print or check with your bank.)
So if you pay off your $1,000 balance in full during the grace period, you’ve avoided interest.
But what if you don’t pay back your balance in full by the due date? Well, your bank will do a big happy dance, because this is when they’ll really start making big bucks.
When you get your monthly statement, you’ll have the choice of making a minimum payment — usually around 1% to 3% of the statement balance plus interest or $25, whichever is greater. If you owe less than $25, your minimum payment will often be the full balance. You can also opt to pay an amount that’s more than the minimum payment but doesn’t cover your full payment.
So suppose the 18% APR card you charged your refrigerator to has a minimum payment of $25. You decide to make only the minimum payments, and you never charge another purchase to the card.
You’d spend 62 months paying off the card. You’d pay $538.58 in interest. That means your $1,000 refrigerator was really a $1,538.58 refrigerator. Yikes.
If your credit card bill is due at an inconvenient time — say it coincides with your rent and car payments — try calling your card issuer and asking them to move the due date. They’re likely to work with you, especially if you’ve established a history of on-time payments.
WHY WOULDN’T I JUST STICK WITH A DEBIT CARD?
With a debit card, you’re spending money from your bank account instead of borrowed money. It sounds appealing because you can usually avoid fees and interest, plus there’s way less temptation to overspend. But here are some advantages of using a credit card.
Credit card companies usually report your payments to the credit bureaus. If you make your payments on time and keep your balance low (less than 30% of your total available credit is recommended), you’ll improve your credit over time. That will help you later if you apply for a mortgage or car loan.
You’re better protected against fraud when you use a credit card. With a credit card, you won’t be responsible for more than $50 worth of fraudulent charges, and most cards will waive even those charges. But if someone uses your debit card to make purchases illegally, you could be on the hook for up to $500 if you report unauthorized charges more than two business days after learning about them. Of course, there’s a good chance that your bank would refund fraudulent debit charges, but the real nightmare comes if the charges result in an overdraft.
You can take advantage of credit rewards. Many credit cards offer rewards like cash back and airline miles. Typical rewards will amount to 1-2% of your purchases, although some cards let you earn extra points when you spend in certain categories. Just remember: Using a credit card for the rewards only makes sense if you can pay off your balance in full each month, because your interest payments will cost more than the value of any rewards you earn.
Your purchases are more likely to be protected with a credit card. Many cards offer sweet protections for the purchases you make using your card. These often include extended warranties, guaranteed returns, and price protection in the event that the price for something you buy drops right after you purchase it. Some cards even offer cell phone replacement if your phone is damaged or stolen and you pay your bill using your card. Contact your credit card company to find out what it offers.
A credit card can be handy in emergencies. Look, we want you to only spend money that you have. But we get that life happens. Sometimes, in an emergency, a credit card can be a lifeline that helps you pay for your necessities.
03 Types of Credit Cards
Now that you know the way credit cards work, let’s look at some common types of cards.
SECURED CREDIT CARD
With a secured credit card, you put down a deposit, and your bank gives you a line of credit that’s around the same amount. Basically, you use your deposit as your line of credit. Secured cards are a great option if you’ve never had a credit card or are rebuilding damaged credit. Just remember: These cards charge interest just like a regular card, so try not to spend more than you can afford to pay off in full each month.
The good news is that after you make on-time payments for about a year, your bank will often give you an unsecured line of credit, which doesn’t require a deposit. You’ll also get your deposit back when the bank approves you for an unsecured line of credit or you close your account, provided that you’ve paid off your balance. (Note: The other types of cards we’ll discuss in this section are unsecured.)
BALANCE TRANSFER CARD
A balance transfer card lets you move your balance from one card to another. Getting one can be a smart move if the new card has a lower APR than your current one, especially if it offers a 0% interest introductory period. Interest-free periods typically range from 12 to 21 months.
These cards usually require good credit. Expect to pay a transfer fee of 3-5% of your transferred balance.
Rewards cards give you perks for spending money on your card. These cards often require above-average credit, and annual fees are common. Here are some common types of credit rewards:
- Cash back: When you make a purchase, you’ll get a refund of the price you paid, often through a credit to your account, check or prepaid gift card.
- Travel rewards: These cards let you earn points that you can redeem for plane tickets or hotel stays. Some are co-branded with certain airlines or hotels.
- General rewards points: These cards give you points that you can redeem for gift cards or merchandise from the bank’s online shopping mall.
STUDENT CREDIT CARDS
These cards are designed for students enrolled in college who don’t have much credit history. They typically have low limits and don’t offer many rewards, but they help students establish credit.
Retailers will often try to get you to sign up for a credit card at checkout by offering you a discount on your purchase. There are two types of store credit cards:
- Closed-loop cards, which you can only use at the store that gave you the card.
- Co-branded cards give you discounts and rewards for shopping at the sponsoring retailer, but can be used anywhere that accepts the card’s payment network, i.e., Mastercard or Visa.
Closed-loop cards typically have lower limits and higher interest rates than a regular credit card. If you have a low credit score, it may be easier to qualify for a closed-loop store credit card than a regular credit card. With co-branded cards that aren’t limited to a certain retailer, expect interest rates and requirements to be similar to any major card.
Keep your credit utilization ratio in mind, especially when you make a purchase on a closed-loop store card. Because their limits are often low, even a small purchase could push your credit utilization ratio above the recommended maximum of 30%.
04 4 Factors to Consider When You Choose a Card
By now, we hope you have a good idea of what kind of credit card you’re looking for. Yay for progress! But before you home in on the specific card you want, you’ll have to do more homework to make sure the offer works for you. Here are four factors to look at.
Ideally, your APR wouldn’t matter, because you’d pay off your balance in full each month. But you still want the lowest APR possible, because that means you’ll pay less money in interest if you do need to carry a balance.
Also look at whether the APR is fixed or variable. If it’s fixed, your interest rate can only go up in the first year if you’re more than 60 days late on your payment or your promotional period ends or you complete a debt management program. After that, the issuer must give you 45 days’ notice.
A variable interest rate means your rate will go up if the Federal Reserve raises interest rates. Your card issuer isn’t required to give you advance notice.
When you apply for a credit card, a bank does a credit check that appears as a “hard” pull on your credit report. Lots of hard pulls can decrease your credit score, so you want to be realistic about your odds of approval before you apply.
Many cards give you a zero-percent interest period or bonuses — sometimes worth $500 or more — when you charge a certain amount within the first few months.
Just remember: Credit card companies make lots of money when you carry a balance from month to month, so be sure you can pay off your card in full by the time your interest-free period ends. Likewise, interest charges will quickly eat up any bonus points you got from a sign-up offer.
REWARDS VS. ANNUAL FEES
The average annual credit card fee (for cards that actually charge a fee) is $147, according to a 2018 ValuePenguin study. So is an annual fee worth it? It depends on your spending habits and the card’s rewards.
If you charge $10,000 a year to a card with an annual fee of $147 that gives you 2 points for every dollar you spend, you could easily come out ahead, because your rewards will probably add up to $200. An annual fee may also make sense if you frequently take advantage of the protections we described earlier.
But if you don’t make frequent purchases, you might not earn enough rewards to make an annual fee worth it.
Regardless, be aware that credit card rewards programs can change at any time, so it makes sense to use your points sooner rather than later.
05 How to Apply for a Credit Card
To get a credit card, you need to be at least 21. If you’re not of drinking age, you’ll need a parent to co-sign or proof that you have sufficient income on your own.
When you find a card you want, you’ll fill out an application (usually online) that will ask for information such as your name, Social Security number, date of birth, annual income and whether you rent or own your home. Then, the lender will pull your credit to determine whether to approve you.
WHAT HAPPENS IF YOU’RE APPROVED?
If you apply online, you might be notified within just a few minutes that you’ve been approved. Or the issuer might ask for additional information before approving you. When you get approval, your lender will also tell you your credit limit and APR.
To access your line of credit, you’ll have to wait for your card to be delivered by mail. Expect to wait at least seven to 10 days, although you might be able to pay to have it expedited. When the card arrives, you’ll activate it online or by phone, and then you can start using it.
If you’re hoping to boost your credit score by getting additional credit, try asking one of your current card issuers to increase your limit before you apply for a new card. It’s better for your credit than a new card, because a new account lowers the average age of your credit, and applying for a new card results in a “hard” inquiry.
WHAT HAPPENS IF YOU’RE DENIED?
Your application for credit can be denied for lots of reasons, including a low credit score, not enough income, having too many credit cards or having an account in collections.
If you’re denied, you’ll get something called an adverse action letter in the mail that tells you why your application was rejected. The letter will also include information about how to obtain a copy of the credit report that was used to make the decision so that you can check the report for errors.
Your next steps depend on why the application was rejected. If your score was too low, consider waiting until you’ve made six months’ worth of consecutive on-time payments before applying for another card.
But if you have no open credit — either because you’re new to credit or you have bad credit — you might run into this annoying Catch-22: To get credit, you often need to already have credit.
If you’re rejected for multiple unsecured cards, consider saving up for a deposit and applying for a secured card.
You might also be able to build credit by getting a family member to add you as an authorized user to one of their cards, which means you’ll be allowed to use the card, but you won’t be financially responsible for it. Make sure the person who adds you pays on time, though, because late payments will hurt your credit score. And of course, do NOT abuse this very generous privilege by making any purchases you don’t have permission from the account holder to make.
Getting a co-signer — someone who agrees to be responsible for the card if you don’t make your payments — could also be an option, although many major banks are moving away from giving credit to people who don’t have the ability to foot the bill independently. If you’re hoping to get a card with a co-signer, your best bet may be to apply through a local bank or credit union.
06 What to Do if You’re Struggling With Credit Card Debt
OK, but what if this isn’t your first credit card rodeo — and now you’re struggling to pay even the minimums? You have options, but the most important thing to remember is that you can’t run away from credit card debt. Your best option will depend on a number of factors, including how behind you are and how much you owe.
A late payment or an account that gets sent to collections will stay on your credit report for seven years, so it’s essential to be proactive.
HOW TO LOWER YOUR PAYMENTS
If you’ve been making on-time payments on your card, you may be able to get your credit card company to lower your interest rate.
If you have good credit, you might want to apply for a balance transfer card, preferably one with an introductory zero-interest period.
Another option is to take out a personal loan to pay off your credit cards. The good news is that personal loans tend to have lower interest rates than credit cards, but you need to be sure you can pay your lender a fixed amount for the next two to five years.
WHAT IF YOU CAN’T AFFORD YOUR NEXT PAYMENT?
If you know you can’t afford a payment, it can be tempting to avoid your creditors. But it’s important to talk to them ASAP.
It’s often in your creditor’s interest to negotiate with you. Third-party debt collectors typically purchase seriously delinquent accounts for pennies on the dollar, so your creditor might be willing to work with you. The key is to talk to your creditors before your account is sent to collections — and ideally before you’ve even missed a payment.
If you’re experiencing a hardship, your credit card company might agree to a forbearance or hardship plan that lets you miss a few payments. Or your card issuer may agree to a workaround plan that lowers your interest and wipes out late fees.
If it’s a one-time slip-up, make sure you don’t fall short on funds again by working credit card payments into your budget.
But if you’ve cut all the fat out of your budget, your only solution is to make extra money. Consider taking on a side hustle, or try a few of these clever ways to make money at home.
WHAT IF YOU’RE ALREADY BEHIND ON PAYMENTS?
If you’re already behind on payments, you can still negotiate with your credit card company.
Offering to pay a lump-sum settlement will probably get you the best deal. You may also be able to work out a payment plan, but you’ll end up paying more over time than you would if you settle for a lump sum.
A debt management program can help you pay off your debt in three to five years. It won’t hurt your credit, and it’s regulated by strict guidelines.
A less ideal option is to work with a debt settlement company that will negotiate on your behalf. The company will stop making payments on all your debts while they negotiate, lowering your credit score even more and increasing the number of creditors calling you every day. Then at the end, you’ll pay them a fee of 20-25% of the settlement amount.
- Debt collectors are required to provide proof that you owe the debt.
- They can’t call you before 8 a.m. or after 9 p.m.
- They can’t call you at work if you tell them you’re not allowed to take personal calls at work.
- While it’s legal for them to call a family member or friend to find you, a bill collector can’t share details about your debt, and they can only call each family member or friend one time in most states.
WHAT IF YOUR ACCOUNT IS IN COLLECTIONS?
When your account is sent to collections, you’re no longer dealing with the bank that issued you the credit card; you’re dealing with a third-party agency. Even though dealing with debt collectors is scary, it’s important to remember that you have rights. Here are a few of the protections afforded by the Fair Debt Collections Practices Act:
While you could get sued over an unpaid credit card bill, this usually only happens after multiple collections attempts. Most creditors and collectors would rather negotiate with you than take you to court.
If you’re struggling with multiple accounts in collections, Chapter 7 or Chapter 13 bankruptcy might be possibilities.
07 5 Tips for Using Credit Cards Responsibly
Having access to credit carries big responsibility. As we learned in the last section, the decisions you make with that piece of plastic could affect your finances for years to come. Here’s how to make sure that card works for you, not against you.
PAY YOUR BALANCE IN FULL
We can’t repeat this enough: Only use your credit card when you can afford to pay off the balance in full at the end of the month, unless you’re facing a serious emergency. Interest charges will erase any benefits you earn from rewards, and as you spend money on credit card payments, you risk having to charge more expenses to your card.
You may have heard the myth that carrying a small balance from month to month will improve your score. Do not believe this myth. While you do need to use your card regularly to build a credit history, carrying a balance will NOT boost your score.
SET UP AUTOMATIC PAYMENTS TO COVER THE MINIMUM
Making on-time payments is the most important thing you can do for your credit score.
Paying on time will also help you avoid fees. A late payment could cost you anywhere from $25 to $38 in fees, plus your bank could raise your interest as a result.
To make sure you always make payments on time, set up an automatic payment for the minimum amount through your bank. You can go back later and transfer the remaining amount.
You could also try Tally, a simple app that lets you store and manage your credit card payments in one place, optimizing the amounts and times.
Simply download the iOS app, scan in your credit cards, and if you qualify (with a minimum credit score of around 675), Tally will give you a line of credit with an interest rate between 7.9% and 19.9%* and use the lower interest rate to make managing your payments easy.
No more missed payments. Lower interest rates. All in one place. And don’t worry, Tally uses bank-level security, so your information is safe.
Tally is currently available in Arkansas, California, Colorado, Florida, Illinois, Louisiana, Massachusetts, Michigan, Minnesota, New Jersey, New York, Ohio, Texas, Utah, Washington and Wisconsin.
*Your APR (which is the same as your interest rate) will depend on your credit history and varies with the market based on Prime Rate. Accurate as of July 2018.
AVOID CASH ADVANCES
With a cash advance, you can use your credit card at an ATM to get money. However, it’s a super-expensive way to access cash, and it’s best avoided unless you’re in the direst of emergencies.
A typical cash advance has a fee of 5% of the withdrawal or $10 — whichever is greater. Interest rates for cash advances average 23.68%, nearly 8 percentage points higher than a typical credit card. Plus, the grace period you usually get with credit cards only applies to purchases. With a cash advance, interest starts to accrue right away.
ONLY BUY THINGS YOU NEED
Before you charge something, ask yourself if you would still be buying it if paying cash were your only option. If you’re only buying because you won’t have to pay the bill in full or right away, or you’re justifying the purchase because of the points you’ll earn, walk away.
MONITOR YOUR ACCOUNT ACTIVITY AND CREDIT REPORTS
Log in to your account regularly to check for activity you don’t recognize. If you spot a purchase you don’t think you made, contact your card issuer immediately. Any fraudulent charges will usually be credited back to your account ASAP. You’ll want to ask for a new card with a new account number so you can put a stop to any more bogus charges.
Also, make sure you monitor your credit reports to check for fraudulent activity and inaccurate information. You’re entitled to one free credit report from each of the three bureaus every 12 months. To order yours, simply head to AnnualCreditReport.com.
To keep a closer eye on your credit, get your credit score and a “credit report card” for free from Credit Sesame. It breaks down exactly what’s on your credit report in layman’s terms, how it affects your score and how to address it.
Because it simplifies everything, you should be able to spot any errors. For instance, if you find an “unpaid” credit card that you know you paid, or a bill in collections you know never existed, you can dispute the incorrect information and raise your credit score.
You’re now ready to enter the world of responsible credit carding. Put this knowledge to use and your credit card will fatten your credit score, rather than a bank’s bottom line. This action plan will help you make sure you’re using your card to your advantage.
Shop for a card by looking for one that caters to people with similar credit, and then compare APRs, rewards, fees and sign-up offers.
Check your credit card balance every few days to make sure you’re not overspending. That will keep you on track, so you can pay off your balance in full by your due date. And you can also check for transactions you don’t recognize.
Create a budget that accounts for monthly credit card payments.
Set up automatic transfers from your bank to be sure you’re always covered for at least the minimum payment.
Obtain your credit reports from AnnualCreditReport.com to confirm all information is accurate.
Call your credit card company about your options before you fall behind on payments.