Advice: Credit Cards 101 & 202

Top ten things you need to know about credit cards.

Credit Cards 101

1. You probably want one or more credit cards. Used responsibly, a credit card gives you many benefits, including consumer protections as well as improved cash flow / rewards, that are not available from other payment sources. We’ll explain “used responsibly” as we go. You do not have to pay interest to get these benefits.
2. Your debit card is not a credit card. If your bank gave you a card just for opening your account, it’s a debit card, not a credit card even if it says “Visa” on it. You have to apply to get a credit card. Debit cards take money from your checking account immediately. Credit cards don’t.
3. A credit card is a pre-approved loan up to your credit limit, which lenders come up with based on your application. As loans, credit cards build your credit history when you use them, and can help your credit score if you don’t borrow much and pay it back every month. This is one of the few ways to build credit at no cost.
4. The grace period is your friend. If you are paying off your statement balance each month, you will not be charged any interest on new charges. This can be up to six weeks, thus the cash-flow benefit. But beware: if you don’t pay off the balance, your grace period is gone, and all new charges will accrue high interest until you again pay off the statement balance. There is no difference to the card company if you pay once / month or multiple times / month, though it may reduce your credit utilization which is usually good.
5. The 20%+ annual APR common to credit cards is NOT your friend. You want to avoid this at all costs. This means you never charge more than you can pay off each month, even if you still have credit limit left. While the “minimum payment” may not seem that bad, if you paid off a credit card balance using only minimum payments, you would pay up to three times as much for everything as if you paid it off immediately. If you find yourself shopping for lower APR, like 15%, that’s still bad, since you shouldn’t be paying interest at all.
6. More credit is granted to people with good credit. What if you have no credit? To get started, you should look for a card designed for people with no credit, like a secured credit card, or something from your bank or credit union. With a secured card, you are basically borrowing your own money, since you put down the money to back your credit limit. It’s like training wheels or a learner’s permit. Once you have shown you can do this, then you can use other people’s money. Not much to start, though; initial credit limits are usually below $1000. It’s possible to get $20,000+ limits on a card if your history is good enough.
7. More credit cards is usually better, eventually. Go slow, though; maybe 1/year to start. Getting a new card increases your available credit, and increases your number of accounts, both of which help your credit score. This at the cost of an inquiry, which will be less-than-helpful for a couple of months. Note that requesting a credit limit increase sometimes produces an inquiry as well. There is no such thing as too many credit cards from a scoring standpoint, but taking out a lot of credit in a short period of time makes you look like a bad credit risk. You also don’t want to have more cards than you can manage. Forgetting to make a payment is bad. Closing a credit card won’t help your credit score.
8. Zero-percent promotional rates are good but can be risky. Once you have a credit history, you’ll eventually be offered zero-percent promotional rates. These are generally speaking good for you, especially if you would otherwise be paying interest. In some cases, you can even transfer balances from other cards. Just remember you need to pay everything off, and that’s easier said than done. The card companies hope you don’t. Be aware of the difference between promotional 0% and deferred 0%, as well.
9. Rewards are a good thing. Once you have a good credit history, you will be able to get rewards cards that rebate 1%+ of your credit card expenses you. (Merchants pay this indirectly, as a portion of the 2-3% fee taken from them when you use your card.) You want to do this. Some cards offer extra rewards for initial spending to get you to apply. If you can get the extra reward, it’s usually worth it.
10. Reminder to be responsible. Not everybody is. If you know you have limited self-control, then credit may not be for you. People who use credit may overspend on unneeded purchases. (“Hey, I’m getting rewards!”) Credit cards are not your emergency savings. Most of the saddest stories I have heard are people who got $10,000 or even $50,000 in debt because they spent too much. Don’t let this be you. Be careful out there!

Credit Cards 202: Beyond the Basics

1. Banks make money from you on interest and fees, including late fees and annual fees. You can control those; you don’t have to pay any interest or fees unless you do something you agreed to. They make money from merchants on interchange fees of 2 to 4 percent. Merchants do not usually charge more for credit transactions, though they could in some cases. Interchange fees are higher if the card is not physically present, if you are getting rewards, and on American Express transactions.
2. Your ongoing rewards come from these interchange fees. Initial spending bonuses come from the bank as a marketing cost. You can choose different types of rewards: cash, miles, or points that turn into cash or miles. You have to decide which you want, there’s no universally best choice. (Asking someone else what is the best card for you is generally futile, since they won’t know what works best for you.) Cash is, well, cash. Miles/ points can be worth more than cash, but only if you would spend them anyway. The best initial spending bonuses will be miles / points. If you don’t mind the impact of getting additional cards and can meet the spending targets, the best rewards percentages come from collecting initial spending bonuses; these can be 10% or more of that initial spending.
3. The very best initial spending bonuses come from cards with annual fees; you have to factor that into the equation, but you still can come out ahead in the same 10% range on initial spend, especially if fees are waived first year. You may not want to keep paying annual fees, though, so this is where a product change comes in. Before the fee comes due, you can ask to switch to a card with no annual fee, but keep the same card number, credit limit, and history. You don’t get an initial spending bonus with the new product, but you would get other benefits.
4. Ask for what you want; some things are negotiable. You can sometimes get fees like annual fees or late fees waived as a courtesy if you are otherwise a good customer and they want to retain your business. You can almost always get the statement billing / due dates changed to something that works better for you, just by asking.
5. Let’s look at some other things you can get with credit cards. My Chase Sapphire Preferred card provides these, described in a 47 page booklet full of small print covering details: a) car rental collision damage waiver, as primary coverage; I can decline the car rental company “insurance” without concern; b) various types of purchase protections, including extended warranty coverage, price protection, and return protection; c) trip cancellation / interruption insurance, due to e.g. accident/sickness, severe weather, or travel company bankruptcy; d) lost luggage, trip delay and travel accident benefits. e) This card also provides no fees on transactions in foreign currencies. Credit cards provide better exchange rates than cash / ATMs.
6. We alluded to consumer legal protections previously. The two cases that are most important to you are: 1) if a card is lost or stolen (or, the number breached in any other way, even if the card is not physically involved…), your liability is legally limited to $50, and in practice, is usually zero. You do not have to pay for charges you did not authorize. Note that in this case, you card will be cancelled and re-issued with a new number, but the same credit limit and history. 2) if a merchant charges you something you disagree with, e.g. overcharge or defective product, you have the right to contest the charge, and the amount in question will be excluded from your bill until the dispute is finalized. Debit cards do not have to offer these same protections; for example, lost debit card liability can exceed $50 if not reported in 48 hours, and banks do not need to reverse debit card charges during disputes.
7. Balance transfers can be helpful if you transfer to a 0% promotional rate card, but watch out for fees. You may be charged one-time interest of 3% or so. Cards from banks like Citibank allow you to transfer balances from student loans and car loans, too. Don’t get carried away though since the term of these loans is very limited, and then interest goes up substantially. Be sure to read the fine print in your credit card disclosure about how balance transfers and new charges interact in terms of how payments are applied, too.
8. Cash advances from credit cards are never a good idea. Your credit card is not an ATM card. This also applies to so-called “convenience checks.” You are typically charged a one-time fee of a few percent, have a higher interest rate, and, most importantly, you get no grace period on these transactions. Just say no.
9. If you have self-employment income, you can apply for a small business card. This allows you to keep business expenses distinct from personal expenses, which can be helpful at tax time. Some small business cards also do not report against consumer credit bureaus, which may be a help if you want to minimize the impact of business utilization on your personal credit score. (But you could not use this to help your consumer credit history.)
10. Final plug for being responsible. Only use a credit card as you would use an old-school charge card, where you pay off the balance in full each month. We’ve already explained that paying the minimum only is a disaster, but then that’s exceeded if you become 60 days late on payments, which will invoke not only late fees, but also penalty interest of 30% for at least six month. This can also result in increased interest rates on cards that you are not late on!