Basic Components of Credit Cards

There are four components of credit cards to understand:

Unsecured vs Secured – Secured credit cards require collateral in exchange for approval of a credit card from financial institution. Collateral commonly being funds deposited into an account at the financial institution issuing the credit card (typically upwards of $300 or more). Unsecured credit cards do not require such collateral.

Interest/Fees  – Interest rates of credit cards vary between 9.99% and 29.99%, but can go higher/lower depending on your credit score and relationship with financial institution. Common fees include annual fees, balance transfer fees, cash advance fees, and other service fees.

Rewards/Intro-Bonuses – Rewards for using a credit card could be points, cash-back, travel miles, and more. Most cards have one or more ways to earn rewards. Intro-bonuses are bonuses for opening a new credit card with the financial institution. Intro-bonuses could be 0% interest for the first 12-18 months, cash-back or bonus miles if you spend a certain amount within 60-90 days, or something else enticing.

Statement Cycle vs Pay Period – Statement cycle is the timeframe of your purchases, typically 30 days. Pay period is how quickly you need to pay back those purchases after the statement cycle ends, typically 21 days or longer. For example: If your statement cycle for purchases is June 1st to June 30th, your payment could be due July 21st.

Benefits of Using a Credit Card

Debit cards directly debit the funds in your checking account. Credit cards are funds borrowed from a financial institution, that you pay back on a monthly basis. In other words, they are a line-of-credit you could use for purchases instead of using the funds within your checking account. This enables credit cards to be useful for emergencies, fraud protection, and building credit history.

Unlike debit cards, credit cards also typically earn rewards for using them. For example: A cash-reward credit card earning 3% cash-back on purchases will earn $30 a month, or $360 a year, if you spend $1,000 per month on such credit card. In addition, institutions could have intro-bonuses that double that cash-back reward, or offer 0% interest while using it for the first year.

Out Take.. Good or Bad?

It’s very easy to get approved for several credit cards, use all of the credit limit an institution gives you, and find yourself in overwhelming credit card debt with a high interest rate. Many financial advisors advise against credit cards for this reason.. But if you use credit cards reasonably, they are a very dependable financial tool to have. Credit cards allow access to capital you may not have now, but will in the near future, for an emergency or other time-sensitive purchase.

We recommend credit cards for most people. We do not recommend credit cards for people already in debt, have bad spending habits, or have financial goals that credit cards interfere with.

Credit cards should be used for three primary reasons:

Building Positive Credit History – The longer you have a particular credit card in good standing, the more of a positive impact it’ll have in increasing your credit score and history. It’s important to always pay on time to remain in good standing.

Rewards and Perks – Rewards a credit card offers are incentives to use the card on purchases you would be buying anyways. Cash-back cards are essentially a 1-5% discount on everything. Point cards and travel cards contribute towards airline tickets, hotels, and other travel expenses. Some cards also come with additional perks, such as; Airline and hotel upgrades, Uber/Lyft credits, cash-back bonuses for spending at certain stores, and other notable incentives.

Fraud Protection and Emergencies – Fraud protection meaning if your credit card is lost/compromised and someone makes purchases with it, you are not liable up and the funds were not directly debited from your checking account. Emergencies meaning if you suddenly have car repairs, or missed a couple unpaid work days, you have a way to purchase your day-to-day expenses until the next couple paychecks come in.

Credit cards serve a purpose for everyone, but it’s important to reiterate how to use them positively towards your financial goals.

Reminder – Do not spend more than 40% of your credit limit on a credit card. For example: If your credit limit is $1,000, don’t have a balance above $500. Payback at least 3-5 times the monthly minimum amount due. For example: If your monthly minimum amount due is $35, you should budget to pay $105-$175 instead.