A credit card is a common financial tool that allows users to pay for goods and services by borrowing money.
Credit cards are often compared against their sibling, the debit card. The main difference is that using a credit card generates a loan with interest charges, whereas a debit card is a direct withdrawal of money from your checking account.
You might be asking yourself: why would I ever use a credit card if I have to pay back however much I just spent? Isn’t that just the same thing as a debit card, but with more steps?
Credit cards offer many distinct advantages over debit cards because they allow you to:
- Build your credit score
- Defer loan payments from other loans
- Fight against fraud
- Get sign-up bonuses, and
- Earn free perks and rewards.
Perhaps the biggest takeaway is that you cannot earn points, awards, or cashback using a debit card. By being smart with your credit card, you will essentially be getting free money.
Who doesn’t like free money?
What Are The Key Credit Card Terms?
Before we delve into credit cards, let’s make sure to define the jargon.
When you sign up for a credit card, the interest rate, or annual percentage rate (APR), is displayed front and center. The APR is simply the interest rate used to determine how much interest you’ll have to pay if you forget to pay off your credit card.
For example, if your card has an APR of 25%, and you owe $500, then after a year of not repaying that sum, you’ll owe an extra $125. Credit card APRs are usually really high —do not forget to pay your bill.
A credit card has a credit limit, which is the maximum amount of money you can spend on the card. Some cards might even have an annual fee, an extra charge that some companies charge for you to have their card. These fees usually appear in cards with rewards—it’s up to you to determine how much you might need to spend to offset those fees and to beat the system.
When you look at your credit card bill, you’ll see a billing cycle. At the end of the billing cycle, you will have until the start of the next cycle to pay off your bill to avoid paying interest on your expenses.
What Is A Cash Advance?
Credit cards allow you to withdraw money from an ATM in what is called a cash advance. One thing that you need to be aware of is that you should avoid doing this at all costs for two reasons.
The first is that most credit card companies will charge you a cash advance fee. It will either be a % of the amount withdrawn or a flat fee.
The second reason is that the APR interest rate on a cash advance is much higher than the purchase APR. For example, a friend of mine with an excellent credit score has a purchase APR of 15.99% on his credit card. However, the cash advance APR is a whopping 24.99%.
For that reason, you should always use a debit card to withdraw money from an ATM unless it is an absolute emergency.
Why Get A Credit Card?
Credit cards tend to have a negative stigma surrounding them, but I think this is partly because of misunderstanding and poor credit card practices.
If used correctly, these thin slabs of plastic (or metal) can be one of the best tools in your financial toolkit. Let’s go through some of the benefits of credit cards:
Building Your Credit Score
Your credit score is a number that can help you save a lot of money; in brief, a higher credit score qualifies you for lower interest rates on mortgages and loans.
By paying your credit card on time, keeping the amount of money you owe low, and owning credit cards for a long time, you can keep your credit score relatively high. However, generally speaking, if you don’t own a credit card, then lenders could see you as “untrustworthy,” leading to higher interest rates.
Thus, credit cards are one of the best ways to maintain a healthy credit score. You can check your credit score using free tools like Credit Sesame!
Defer Loan Payments To Your Card
Say you have $1,000 of debt with a 20% interest rate per year. If you don’t repay off that debt in a year, you’ll owe $200 to the lender. Ouch.
Thankfully, some credit cards offer balance transfers that allow you to move high-yield debt onto a credit card. This transfer is advantageous considering that when you open a new credit card, some issuers offer 0% APR for some period.
Let’s reimagine the scenario above using a balance transfer. Say you still owe the same debt, but now you open a credit card with a balance transfer option and 0% APR for the first year. You then shuffle your debt onto your shiny new credit card. Now, after a year, you owe $0 in debt interest!
Using balance transfers appropriately can literally save you thousands of dollars.
Fight Against Fraud
More scenarios time! Let’s say a thief stole your debit card. If you report the theft within two business days, you won’t be liable for more than $50. However, if you wait any longer, then you could be responsible for up to $500. The worst-case scenario is that you don’t report it until after 60 days, after which you could have to pay for all of the damages.
On the other hand, credit cards offer some of the best protection against fraudulent use.
If your credit card is stolen, you still need to notify your credit card company, but they deal with checking the transactions. Visa and Mastercard even offer “Zero Liability Policies” that guarantee you won’t be held against fraudulent charges. Consequently, credit cards give a bit more peace of mind since you’ll know that you’ll get your hard-earned money back.
Get Sign-up Bonuses
Generally speaking, credit cards usually offer rewarding sign-up bonuses when you first open them. For example, the Chase Sapphire Reserve has a $750 signing bonuses while the Capital One Quicksilver has a $150 bonus after spending $500 in the first three months.
Earn Free Perks And Rewards
This is what you’ve been waiting for.
Credit cards offer some very lucrative rewards. Imagine spending $100 and getting $5 back. Think about how much money you spend on groceries every month; some cards reward you for using your card at supermarkets.
Not to push the envelope, but you can even earn free airplane flights over time.
Reward cards are free money just waiting for you. Don’t miss out on them.
How Do Credit Cards Work?
If a credit card didn’t make the issuer money, then credit cards wouldn’t exist.
Unsurprisingly, credit cards are one of the most profitable products that institutions offer. Firms make money off of exorbitantly high APRs if you miss payments, and when you swipe the card for a transaction. Despite some cards even offering 5% cashback, credit card organizations still make money when you use your credit card.
The exact details are a bit complicated and out of this article’s scope, but for simplicity, what you should take away is that credit cards exist since they make a lot of money for the issuer. The best cards out there exist because they can make a lot of money for the intuition offering the card.
How Does Credit Card Interest Work
When you use your credit card, you start to accrue a loan. At the end of the billing cycle, which is about 30 days, you will have until the end of your next billing cycle to pay off that loan. If you fail to pay off the money you owe by the end of the next cycle, you will be subjected to the credit card’s APR.
The higher the owner’s credit score, the lower the interest rate. Individuals with a fair credit score can face APRs around 20-25%, whereas those with excellent credit scores (800-850) can face APRs around 10-15%. This drastic difference in rates can save hundreds or even thousands of dollars.
How Do Credit Card Rewards Work
Credit card rewards vary from card to card, but the general idea is that when you use your credit card to pay for purchases, you’ll get some money back.
The better the card, the better the rewards system. Thus, if you maintain a high credit score, you’ll get extremely nice benefits on your credit cards.
I talk more about the different types of rewards in the next section!
Understanding Credit Card Billing Cycles
Credit billing cycles work very differently than debit card purchase cycles. When you open a credit card, you start with a zero balance and your billing cycle begins. Billing cycles typically range from 28-31 days depending on the card. During the cycle, all purchases made will be added to your statement balance.
At the end of the 28-31 day cycle, your statement will be finalized and you’ll know how much you owe. At the same time, another cycle will begin for all purchases in the new cycle. However, the payment due date on the first cycle is typically is 21-25 days after the close of your billing cycle.
That means that you might not need to pay the first statement balance until the second cycle is nearly complete! This can be confusing because your payments and balances might not align with how you thought you were spending your money.
It’s hard to remember what we did a week ago, much less 45-50 days ago.
You should note that your due date must always fall on the same day each month. This is mandated by law.
Let’s use an example to make the cycles more clear for you. Assume the cycle starts on the 2nd day of each month and the cycle ends on the 1st day of the next month. So if you open the credit card at the beginning of the year, the first cycle in this example would start on Jan 2. and end on Feb 1.
Let’s assume the due date is on the 20th day of the month. That means that a purchase you made on Jan. 2 won’t be paid for until Feb. 20, which is 49 days later.
The table below will highlight the relevant dates.
|Billing Cycle Dates
|Payment Due Date
|Jan. 2 – Feb. 1
|Feb. 2 – Mar. 1
|Mar. 2 – Apr. 1
Different Types Of Credit Cards
Many different types of credit cards exist, so we’ll cover them in brief below.
|Credit Card Type
|As the name implies, these cards are designed for college students with little to no credit history. It’s relatively easy to open for students, and some cards even have surprisingly good reward perks.
|These cards transfer high-yield debt on one credit card to another. Balance transfer cards are discussed in detail above.
|Rewards cards are probably one of the most exciting and lucrative parts of credit cards out there. After all, you get free money just for using your credit card. I talk about them in greater detail below, but, for example, you can get 5% cashback on your purchases, earn points for free flights and hotels, and more.
We love free stuff, and you should too!
|The business card is usually intended for business owners and offers a wide variety of benefits and perks. For instance, business cards may have higher credit limits, help differentiate personal from business-related expenses, and provide cashback in business categories.
Business cards aren’t intended for the general consumer, but there are exciting ways to utilize them for personal use—an advanced topic out of the scope of this article.
|Secured cards are best for those with no or poor credit history. These cards work by you providing collateral that serves as your credit limit. For example, you give the bank $500, and the bank grants you a $500 credit limit—the bank takes no risk in opening the card for you since if you don’t pay off your bill, the bank is insured by your initial deposit.
Consequently, it’s pretty easy to open a secured card.
|The main difference between unsecured cards and the former is that unsecured cards don’t require collateral.
However, since most people applying for an unsecured card are those with a poor credit score, without collateral, these cards are difficult to obtain, impose high APRs, and have low credit limits.
If you can, go for secured credit cards.
|Charge cards are unique in that they charge no interest rates and offer excellent rewards and perks. While this sounds enticing, they are eligible only for individuals with high credit scores, charge hefty annual fees, and must be paid off by the end of the billing cycle.
Missing a payment on a charge card could destroy the user’s credit score. These cards are only for those who feel incredibly comfortable with credit cards.
Rewards Credit Cards
There are a variety of types of rewards-based credit cards, so I’ll cover most types of them using a table:
|Type of Rewards Card
|Receive some percentage of your money back for every purchase you make. The most versatile type of rewards card available.
|Get “miles” whenever you use your credit card to use towards free flights, hotels, and more.
|Mostly the same ideas as “cash back” cards, except you’re rewarded using points that can be redeemed for free stuff.
You might have also seen that cashback cards, for example, offer varying cashback rates depending on what you purchase. Let’s explore them in greater detail using a table again:
|Types of Cashback Cards
|You earn a set amount of cash back for anything your purchase. For example, a 2% flat-rate cash back card garners $2 for every $100 spent.
|You earn a significant amount of cash back for purchases goods in a particular, rotating category. For example, if the category is “groceries,” you could earn 5% cash back for using your card on groceries instead of only making 1% cash back on gas.
|You earn varying rates of cash back depending on the categories. For example, a tiered card could offer 3% cash back for groceries, 2% cash back for online purchases, and 1% cash back for everything else.
How To Get Approved For A Credit Card
Generally speaking, you usually have to fill out an application to open a credit card. Why?
Remember that whenever an institution opens a credit card account for you, they risk you racking up a lot of debt and then not paying it off—otherwise known as defaulting on debt. Credit card firms will only give you a credit card if they believe the default risk is low.
Since the best credit cards often provide the best incentives to the consumer, they are uniquely available to only those with top credit scores. This fact is because the cost of maintaining lucrative awards is less than the cost of an individual defaulting on their credit card debt.
Thus, these applications serve as a way to gauge the consumer’s overall credit risk.
How The Credit Application Works
A lot of lines in the credit card application make sense once you think about them.
Institutions ask for your gross income because they need to get an idea of whether or not (i) you can pay your monthly credit card debt and (ii) you can pay off the annual credit card fee. They also need (iii) to determine what your credit limit should be.
Think about it this way: if the annual fee for the credit card you’re applying for is $100 a year, and you predict that you’ll rack up $900 in credit card debt over the year, but you only made $500 throughout the year, then how would the credit card company feel comfortable with your ability to pay off even the annual fee?
Going back to the previous example, say your net income wasn’t enough to cover the underlying credit card expenses you accrue. However, your parents might be willing to be a co-applicant on your application, where you can list their income alongside yours.
Having co-applicants can help your credit card application. Let’s add a co-applicant to our story, where they make $2,500 net over the year. Now, your application’s total income is $3,000, covering the entirety of the predicted expenses.
As part of your application, a lender will review your credit history to determine how likely you are to repay a debt. They will look at whether you pay on-time, the amount of existing debt you have, and the type of debt you have.
When Is The Best Time To Apply For A Credit Card
The best time to get a credit card is after you fully understand how they work and how credit card issuers make money off of them.
It is vital to remember a few critical rules before opening a credit card:
- Treat your credit card like a debit card. If you only have $500 in your checking account, do not overspend and rack up $600 in loans with a credit card. Remember: this is how credit card companies make their money!
- Pay off your credit card bills every week. This may seem like a nuisance, but I do this while walking to class, eating dinner, or when I wake up in the morning—it’s become second nature. The advantages of doing this are that you will seldom forget to pay your bills (since they’ve already been paid), you are more aware of how much money you have left in your checking account (following rule 1), and you keep the “total credit used” portion of your credit score at zero.
- Fully understand how your credit score works. There are many facets involved in determining your credit score, and credit cards play a significant role in them. Since one late payment on your card could take over seven years to fix, you probably don’t want to be thinking to yourself five years from now, “why didn’t I read more about this?”
I will reiterate that credit cards are incredibly lucrative products when used correctly. Keep in mind that these credit card firms are hoping you forget to pay your bills to make money off your interest payments. However, if you can play their game safely, you will be rewarded extensively.
How Do I Pick The Right Credit Card
The best credit card for you is determined by what you are looking for in a card and your lifestyle.
If you are just looking to earn easy cash back without much thought, then a flat-rate card is probably best for you. However, if you are savvier and want to maximize your cash back, you could get a few tiered or rotating credit cards to cover multiple sectors, using each card in its specific maximal cashback category.
Perhaps you travel a lot. Then travel or hotel based credit cards would be perfect for you.
Research the cards carefully and see if they fit your lifestyle!
What’s The Easiest Credit Card To Get
Secured credit cards are by far the easiest cards to get since they pose virtually no risk to the issuer.
For college students—even those without much credit history—college credit cards are also particularly easy to get and usually offer a plethora of perks. Firms are willing to invest in students since these people are likely to stay with their first firms for a long time, generating enormous degrees of revenue. Take advantage of the benefits of being a student!
How Many Credit Cards Should You Have
There is no magic number of how many credit cards you should have.
Having too many cards (10+) might make it extremely difficult to manage all the billing cycles, introducing a lot of stress. Though, if you can maintain all of them, your total credit utilization ratio will be low, your credit score will be great, and lenders will see you as a safer investment.
However, having too few cards (<3) could make it harder to keep your credit score high. Your credit utilization ratio comprises 30% of your FICO credit score.
A tangible example might make more sense. If you have two cards, each with $500 credit limits, and you spend $1000 over the billing cycle, your credit score is going to take a huge hit—your utilization ratio is 100% for the month. On the other hand, if you have ten $500 credit limit cards, your utilization ratio would have only been 10%, which is considered “excellent”. See how more cards could make a difference?
Furthermore, having a diverse set of cards allows you to maximize your rewards. For example, I have cards I specifically use for restaurants, online shopping, groceries, and flights. Since different rewards cards cover different categories, having multiple cards allows you to cover more sectors, maximizing your cashback.
It’s really difficult to say what the best number of cards is since everyone is different. Having more cards can make it hard to organize payments but could also help your credit score while giving you more access to a variety of perks and rewards. Having fewer cards makes it easier to manage your cards but limits the plethora of bonuses available.
However, you can still have an excellent score with any number of cards! The FICO credit score doesn’t factor in the number of cards you own.
What Are Credit Card Networks
When you order something online or in person, you might have seen the merchant say something like “we only accept credit cards from Visa, Mastercard, American Express, and Discover.”
A credit card network serves as a way for institutions to communicate with the merchant about a credit card transaction.
Be aware of credit card networks when you think about opening a credit card. For instance, you’ve definitely come across a shop that doesn’t accept a particular credit card network. If you only had credit cards within that network, you might not be able to pay.
As a side note, credit card networks are normally completely independent of credit card issuers. Discover and American Express are some exceptions, serving as both, but Visa and Mastercard are only credit card networks, whereas JP Morgan Chase and Capital One are only issuers.
How Do Card Networks Work?
These networks work by charging a fee on every transaction to appropriately process the information between seller and credit card issuer.
These transaction fees lead some stores to not accept particular types of credit cards or have minimum spending requirements to avoid losing money from these fees.
How Do Credit Cards Affect My Credit Score
Credit cards play a significant role in determining your credit score.
In brief, your payment history, credit utilization, and length of credit history are the most important factors in calculating your score. As long as you don’t miss payments, keep your utilization to credit limit ratio low, and own credit cards for a long time, your score will reflect your efforts.
However, if you miss even one payment, it could take over a decade of perfect payments to correct your mistake. Repeat after me: do not miss your payments. It’s worth noting that late payments are generally not reported until at least 30 days after they are due, so you do have some leeway. Note that this is still extremely dangerous territory to be in, and you’d be playing with fire.
Are Credit Cards With Annual Fees Worth It?
This question depends entirely on the perks and rewards system of the card. Don’t ignore a card just because it has annual fees; rather, take a look at the benefits it offers in tandem to its annual fees to gauge if it’s worth it for you.
Let’s build an argument based on one of the world’s best credit cards: the Chase Sapphire Reserve travel card. This card offers exceptional perks and rewards but presents a hefty $550 annual fee. You might see this and want to skip over it, but the Reserve is a premier card for a reason. Let’s take a deeper look.
The card offers $300 in annual travel credit each year, effectively cutting the cost down to $250 per year. Furthermore, for travel or restaurant purchases, you earn three points for every dollar you spend. These points can then be redeemed for a variety of rewards, such as gift cards and flights; when redeeming points for flights, points are worth 50% more. Consequently, according to Chase’s system, every point is worth 0.015 dollars, which means that you get 4.5% cashback towards flights for simply eating at restaurants or traveling.
This credit card also offers ridiculous perks, including top-tier travel insurance, Priority Pass lounge access at airports, and TSA precheck credit (valued at $100). More recently, they have ongoing deals that offer complimentary Lyft memberships (valued at $199) and DoorDash credit (valued at $120).
We haven’t even mentioned the sign-up bonus of $750. Yep. This card is amazing for those who travel a lot.
Back to the original question: annual fee cards can be worth their face value, but there are certainly annual fee cards that are just bad. Do your research and think carefully about why you would want the card.
What Are The Top Credit Cards?
My favorite section! There are many credit cards out there, so I’ll present some of my favorite cards for each type. Rewards cards are usually combined with the other credit card types, so you might see things overlap.
Before you take a look, let’s cover something very important: referrals.
Credit Card Referrals
Before you apply for your dream credit card, see if any of your friends, family, or colleagues own the card you’re interested in. Some credit cards offer referral perks that award both parties for referring people to the card.
For example, the Discover student cards offer $50 for both the applicant and the referrer—mutually beneficial. A pretty sweet deal if I’d say so myself.
|Credit Card Type
|Discover it Student Cash Back: offers 5% cash back on purchases in rotating categories with a unique $20 “Good Student Rewards” for good grades. A unique sign-up offer of “cashback match” for the first year, equivalent to 10% cashback.
|Citi Double Cash Card: an amazing card that has 2% flat rate cashback with 18 months of 0% APR for balance transfers
|Chase Freedom Unlimited: gives 2% flat rate cashback with a solid intro offer of $150 after spending $500 in your first three months
|Spark Cash from Capital One: unlimited 2% cashback on all business expenses including a $500 sign-up bonus after spending $4,500 within the first three months
|Chase Sapphire Reserve: you can probably tell how much I love this card. One of the premier travel cards out there with a wide variety of benefits and bonuses. You can also look at its little brother, the Sapphire Preferred, for lower annual fees
|Discover it Secured: secured card for those with poor credit that doesn’t charge an annual fee
Some other amazing cards that weren’t mentioned above include the Amazon Prime Rewards Visa Signature Card (5% cash back at Amazon and Whole Foods), the Blue Cash Preferred by American Express (6% cash back at U.S. supermarkets), and the Hilton Honors by American Express (earn points for a wide variety of purchases).
John Ta is an undergrad at the University of Pennsylvania and the founder of Penn’s first undergrad personal finance club, Penn Common Cents. As a first-generation college student, he had to learn everything about personal finance on his own and seeks to mend the financial literacy knowledge gap seen almost everywhere. John is currently studying for an MS in Chemistry and a BA in Physics (business & tech concentration), Biochemistry, and Biophysics and is interested in the intersections of finance and healthcare.