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If you're like most U.S. adults, credit cards are an attractive gadget to have in your financial toolbox. There are 364 million open credit card accounts in the United States, according to a 2018 American Banking Association report, and it's no secret why. By tapping into the funds made available by the issuer, you can safely pay for the things you want and need. As long as you get the right accounts and treat them well, you'll build an impressive credit history and may even profit from the process.
To use a credit card to your best advantage, there are some simple steps you can take. Here is how you can make these powerful plastic tools work hard for you.
How Credit Cards Work
A credit card is a physical symbol of a revolving credit line that a bank or other financial institution grants to you. It's a form of loan, except that instead of taking all the money out at once and repaying it in equal installments, you can borrow just what you need, then pay accordingly.
It all begins when you apply for a credit card. After submitting the application, the issuer will check your credit history and credit scores to determine how much of a credit risk you are. It will also assess your income and, usually, a rundown of your basic household expenses. If you qualify, the issuer will notify you of the good news. At that stage you'll learn what your credit limit is and the interest rate that's tied to the account.
Soon you'll receive a credit card, which will be imprinted with your name, account number, expiration date and a security code—a three or four digit CVV (card verification value). It will also display a symbol from whichever payment network the card uses, such as Visa or Mastercard. Your card will also have a magnetic strip and a computer chip so you can pay at a register or mobile point of sale system (such as Square). The issuer's customer service numbers will be listed and there will be a box for your signature.
When you activate the account by calling the number on the back of the card or using the link written on the acceptance letter, you're ready to charge. Any business that accepts credit cards, in person or online, will let you pay with it, but if you want a cash advance, you'll make the withdrawal at an ATM or by going into a bank branch.
You may charge or extract any amount up to the card's credit limit. The statement will arrive in about 30 days, and on it you will see your account activity, the ending balance, minimum requested payment (typically 2% to 3% of the balance) and the payment due date. If you send at least the minimum by the date listed, the issuer will consider the account in good standing. However, the remaining debt will be carried over to the next month, and interest will be applied.
As an example, let's say you have a credit card with a $2,000 limit and an 18.9% annual percentage rate (APR). Let's also say you charge it up to the limit, resulting in a minimum payment of $60. If you only send that minimum amount, $31.50 in interest would be assessed as finance fees. That means $28.50 would be applied to the principal, which would also be your current available credit. If you paid the total amount owed, though, no fees would be applied and the $2,000 would once again be at your disposal.
Be aware that the APR will be high if you're just starting out in the world of credit, or if you have had credit problems in the past. APRs on cash advances are often higher than for purchases, and unlike with purchases, there is no interest-free grace period, so it starts accumulating when you withdraw funds.
How to Use Your Credit Card Responsibly
In the beginning, responsible credit card use can seem complicated, but it really isn't. Just follow this three-step plan:
- Only charge what you can (and will) repay in full. Although you can pay over time, it's best to carry over no debt. This way you'll avoid interest charges, which can rack up before you know it. Interest on credit cards compounds, which means that it's assessed on balances that have already grown larger with the previous month's interest charges. Another benefit of maintaining a zero balance is that you won't have to face another debt payment the next month and you'll be spending within your means instead of beginning to accumulate debt.
- Don't take it to the limit. Having access to a substantial amount of money is wonderful, but if you charge near or up to the limit, a credit scoring company may calculate your score before you make a payment. It will then appear as though you're highly indebted even if you planned to pay off the balance by the due date. When charging large sums, make several payments before the bill comes due (if you can't pay it in full immediately) to pay it down as quickly as possible.
- Pay on time. Send every payment by or before the due date. Timely payments are listed on your credit reports, and this helps your credit scores. Alternatively, payments that are 30 days or more late will ding your scores, so it's important to always pay your bills on time. To simplify this task, set up automatic bill pay with your bank.
Keep a close watch on your account by checking your account activity often and carefully. There's no need to wait for the statement to be issued at the end of the billing period. Check it daily or weekly on your computer or via the issuer's app on your mobile device. You'll prevent balance surprises, you can make a supplemental payment, and you will catch any problems early.
When to Use a Credit Card
Although you have the option to use your credit card for all types of charges, it's especially wise to use it for online and expensive purchases. That's because credit cards come with strong consumer protection laws. The Fair Credit Reporting Act (FCRA), for instance, gives you the right to dispute charges for items you bought but never received, were not what you ordered, or were damaged.
Another advantage of credit cards is fraud protection. If someone uses your debit card, the money in your checking or savings account can disappear. The bank will likely eventually reimburse you, but there could be a delay. Conversely, if a thief charged up your credit card, typically none of your personal funds will be lost.
In most circumstances, the credit card issuer will catch the fraudulent activity, but if it doesn't, just contact its fraud department and report the matter. The issuer will remove those charges and send you a new card with fresh account numbers. In fact, the FCRA gives you 60 days from when you receive your bill to dispute incorrect or fraudulent charges.
Another great reason to use a credit card is to reap the generous rewards many cards offer. Rewards cards come in a few basic varieties:
- Cash back cards allow you to earn back a percentage of the money you charge as a rebate. Depending on the card and program, you can earn upwards of 1% from each purchase you make.
- Point-based cards give you the opportunity to accrue points with every charge. The points can then be traded in for things such as airfare, products, services and gift cards.
- Travel cards are similar to point-based cards, but the focus is on airline miles or hotel points. When you have enough miles or points, you can redeem them for airfare, hotel stays or upgrades.
Most rewards cards offer introductory bonuses of cash, points or miles that will be yours after meeting the minimum spend, which is typically a few thousand dollars within the first few months of opening the account. You'll profit from these credit cards when you charge liberally and maintain a zero balance, paying off the bill each month (otherwise, finance fees will erode the value of the rewards). Some rewards cards offer increased cash, points or miles when you spend on rotating categories or at certain stores.
Depending on the rewards card, you may get additional perks, such as concierge services, waived checked baggage fees, free entry into airport lounges and extra insurance products. Keep in mind that the better the benefits, the more demanding the qualifications. Some rewards cards charge an annual fee, though you'll come out ahead if you use the card right and maximize the perks.
How Credit Cards Will Impact Your Credit
As soon as the account is granted, the credit card issuer will send your account activity to the credit reporting agencies. That information will be factored into your credit scores. The primary data that will show up includes the date the card was issued and the credit line. It will also indicate your balance and payment pattern. All of this is crucial to a credit score. The FICO® Score* , for instance, ranges from 300 to 850, and higher numbers indicate less credit risk. It's based on five factors, with some being weightier than others:
Payment history (35%): A pattern of on-time credit card payments will definitely help your scores rise.
Credit utilization (30%): The amount of revolving credit you're using divided by the total amount of revolving credit you have available is called your credit utilization ratio. Maintaining no or little debt is best, but if you must maintain a balance, keep it below 30% of your available credit to avoid negatively affecting your credit score.
Credit history (15%): Having a long relationship with a credit card issuer is beneficial. You can't speed up the clock, but you can start charging soon, and keep older accounts active.
Credit mix (10%): One credit card is a fine start, but a couple more plus other credit products such as an auto loan or personal loan will give your scores another push upward—as long as you make your payments on time and as agreed each month.
Inquiries (10%): When you submit a credit card application, you give permission for the issuer to check your credit, resulting in a hard inquiry on your credit report. A slew of such inquiries on different types of credit in a short span of time can lower your score, so apply prudently.
What to Avoid When Using a Credit Card
There are a number of credit card use "nevers" to be aware of. Do not use the card:
- Just for the rewards. It's easy to get caught up in the cash, points or miles game, but it can lead to overspending and debt.
- As an income supplement. Available credit isn't an extra paycheck. If you lean on credit cards to pay for the things you can't afford, your balances will swell and troubles will worsen.
- As a savings vehicle. If you want something special, save for it. Then you can charge the expense and pay the bill with the money you've set aside.
- When you can't afford to pay your monthly bill. A missed payment will remain listed on your credit report for seven years and ding your credit rating.
- For mid- or long-term financing. You may want to spread the payments of an especially costly purchase over time, but don't let it linger for over a year. Charge a $2,000 laptop at 18.9% APR, and the fees would be $112 if you paid it off in six months; stretch it out for six years, and the fees would be $1,358.
- Communally. Never share your account with a friend or family member. The credit card was granted to you, so you're the owner. If you give someone else permission to charge with it, you are liable for the payment and resulting debt.
Credit Where Credit's Due
As you can see, using a credit card in a way that will enhance your life is not just possible, it's also easy as long as you stick to these tried-and-true rules. When you do, your credit scores should improve until they're at the point where you qualify for the premium products that come with top rewards. To make sure you're on the right path, monitor your credit report monthly with Experian's CreditWorks™ Basic plan. It's free, and you'll always know where you stand.