A Beginner’s Guide to Credit Cards

Credit cards are magic little pieces of plastic that allow you to use money without having it, right? Wrong. The reality is that credit cards are magic little pieces of plastic designed to make money for the credit-card companies. Not being aware of your full responsibilities as a credit card holder can bury you deep in debt and significantly limit your access to credit in the future. Therefore, it is crucial for you, the consumer, to be aware of all the little details of credit-card transactions.

A credit card is a valuable convenience, since it means you don’t have to carry cash around anymore. But it definitely does not mean that you can make unlimited purchases and not pay for them, as some people may think. With a credit card, all the purchases you make during a certain period of time are allowed to accumulate, and you receive a bill (statement) for the total amount spent at the end of that time period (usually a month). Once you get the bill, you have a grace period—normally 20 to 25 days—until the due date.

When you receive the bill, you’ll notice you can make a minimum payment, or you can pay the balance in full. In other words, you owe $3,000, but you can make only a minimum payment of $1,000 and keep the other $2,000 for yourself. This is great, right? Wrong again. If you do not pay your balance in full, your credit card company will make money by charging you fees.

Finance charges and late fees: If you have an outstanding balance (money that was not paid on time) on your credit card, you will pay interest on that balance. There are various methods for calculating your outstanding balance (adjusted balance, average daily balance, previous balance, ending balance), so try to understand which method your credit card issuer uses. Credit-card issuers have to disclose the interest rate they charge, so make sure you know what your APR (annual percentage rate) is. If you are billed monthly, the interest rate used to calculate your finance charges will generally be your APR divided by 12. Also, credit -card rates can be fixed or variable, so if yours is variable make sure you understand why it varies and how.

If you pay your balance in full every time, you will manage to avoid finance charges, but it is still important for you to know what they are, just in case. Before you sign up for the card (not after!), read the payment rules carefully (they differ from one issuer to another). If you pay by check, mail the payment early or, even better, pay online. Be aware that paying late may result in an increase of your interest rate in the future.

In addition to finance charges, every time you delay payment you will have to pay a late fee, which can be substantial. It is obviously in your best interest to pay your balance in full every time and as early as possible. Also, when deciding which credit card to choose, look for a card with a low APR. It may have fewer bells and whistles, but it will save you money in the long run. A useful source of information on credit card rates is the website www.bankrate.com.

Annual fees, credit limit fees, cash advance fees, and balance transfer fees: Some credit card issuers charge an annual fee per card, usually assessed on your first statement. Fortunately, avoiding this one is simple: Choose a card without an annual fee. You can also be charged if your outstanding balance exceeds your credit limit. You can probably avoid this fee by requesting a credit limit increase, but this is tricky because then you’ll be tempted to spend more. Card companies generally charge a fee for cash advances, which can be calculated as a flat charge per transaction or as a percentage of the total. You can also be assessed a fee for balance transfers. The point should be clear by now: It is in the credit card company’s best interest to charge you all these fees, and it is in your best interest to avoid them. Make sure you know all the rules, and make all your payments on time.