How Credit Cards Work
Welcome to Credit Cards 101
By: Jennifer Croy
You’ve probably heard all about the evils of credit cards and how you should avoid getting into debt at all costs (pun intended). In this case, you probably don’t know much about credit cards or how they work. By learning proper credit card habits now, you can avoid sinking into debt when the time comes for you to rent a car or buy a house. This crash course in how credit cards work will help you step into adulting.
Soon you’ll become an expert on interest rates, late fees and billing cycles. Sounds fun right?
1. How do credit cards work?
So what makes credit cards different from debit cards? While debit cards immediately draw money from your bank account when you purchase an item, credit cards enable you to buy something and pay it off either immediately or over the course of several weeks or months.
A credit card allows people to make purchases even if they cannot pay for them yet. You borrow money as you spend it, and the bank provides a “grace period” of about 25 to 30 days for you to pay it back. Credit cards usually come with a low spending limit, typically around $300 to $500, especially for students who have no prior credit history. This low credit limit helps students avoid getting into debt and lowering their credit score.
2. How often should I pay the bill?
You must pay your credit card bill at the end of every billing cycle, which usually last 30 days. When paying your credit card bill, you can choose one of two options. You can either pay the minimum payment, a small percentage of your card balance, or you can pay the entire amount in full. If you choose the first option, you can pay smaller amounts each month, but because your debts will accrue interest each month it could potentially take years to pay off a small debt.
The Annual Percentage Rate, or APR, on a credit card determines the amount of interest you will pay. If your interest rate is 15%, you simply divide it by the number of days in a year, 365, and your interest rate will come to 0.04% per day. For example, if you owe the bank $100 and you pay the minimum amount due let’s say $30, you will owe $70 plus the 0.04% interest for every day your payment is late. “One time I missed a payment on the TV I bought with my credit card, and it took me three extra months to pay it off. Since then, I have never missed a single payment,” University of Florida sophomore Tessa Adams said. You can avoid this hassle by using your card sparingly and paying the full amount due each month. If you choose this option, credit card companies will not charge you any interest.
3. What types of fees exist?
Credit card users should pay close attention to the types of fees their credit cards charge because becoming aware of these fees can save a ton of wasted money. Late fees occur when you do not make the minimum payment at the end of the billing cycle. This fee costs up to $27, and if you habitually make late payments this fee will increase. “A few months ago, I asked my dad how exactly credit cards work and the only thing he told me was to always pay it off right away. This didn’t exactly help me understand how they work but it showed me how important it was to pay my bills on time,” UF freshman David Allen said. Some credit cards also have annual fees, charges paid once a year to cover the benefits credit card holders can receive. Most credit cards for students do not charge this fee, but this also means they do not provide as many benefits.
4. What benefits can I receive?
Depending on your bank and the card you sign up for, you can obtain different benefits and perks simply for using it. Numerous credit cards offer cash back on purchases, like if you spend $500 in the first six months you can earn $150 simply for using your credit card. For those straight-A students out there, several student credit cards, like Discover, offer Good Grade Rewards where students can earn cash bonuses simply for maintaining a 3.0 GPA or higher. If you travel often, look into cards with other perks such as frequent flyer miles and hotel loyalty points. Who doesn’t love free money?
5. How do I know if I have a decent credit score ?
In order to receive a bank loan to buy a car you must have a decent credit score. This score ranges anywhere from 300 to 850, and it depends primarily on your credit history. An excellent credit score would exceed the 700 mark. Simply by paying your entire card balance on time each month, you can boost your credit score. When the time comes for you to make those larger purchases, such as a car or a house, you will most likely receive a loan because the bank is confident that you will repay your future debts. If your credit score looks worrisome, they could choose to deny you a loan. It sounds like a ton of pressure, but even a little responsibility can save you from years of debt and financial recovery.
6. Are they a smart financial decision?
If used responsibly, credit cards can help students in numerous ways. You can begin to build credit, which will assist you in the future when you have to make large purchases. “Only use a credit card for small purchases you know you can pay back, like filling your car with gas or buying groceries,” UF financial Advisor Laura Stine said. Some people associate credit cards with evil because they lead to unimaginable debt, but if used responsibly they can make a huge difference in the lives of students especially the ones living paycheck to paycheck.