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Credit Cards Can Be Scary
I'm sure some many people are wary of getting a credit card because of how quickly it can get someone into financial trouble. Plus, as the phrase goes, "cash is king", right? Well there are actually a lot of different ways to make money off of using credit cards and taking advantage of the many bonuses they offer. However, to use them effectively, you need to know the basics of credit card usage.
The difference between using a credit card and a debit card is the very definition of "credit". When you use a debit card, or cash, the money is instantly taken from you or your bank account. However, when using a credit card, you are paying for something by borrowing the money from a credit card company that you will pay back later.
This is where my first warning comes in. In most cases, treat a credit card like a debit card. Do not spend money that you do not already have just because the credit card companies are allowing you a certain amount of "credit".
Only put purchases on your credit card that you have money in your bank account to back up. I say in most cases because as we dive into Part 2 and Part 3, you'll see how sometimes it is good to finance purchases, but only in unique cases. For the case of this blog, only use your credit card on purchases that you can back up with your current bank balance(s).
If you use credit cards in that way, then you are mitigating the risk of falling into credit card debt and you are also reaping the many rewards and bonuses that can come with credit cards. We'll focus more on those next week.
How Do Credit Cards Work?
When using a credit card, you are accumulating costs in a given time period. This time period is considered a statement period. At the end of your statement period, you will have a statement balance. This is where people can get confused.
At the end of each statement you will see three amounts. You will have a total balance, a statement balance, and a minimum payment amount. The minimum payment is all you are required to pay so it doesn't affect your credit score. Because if you miss a payment completely, it will negatively affect your credit score.
However, the statement balance is what you are required to pay in order to not be charged interest on your purchases. Keep in mind there are promos and other financing options that offer 0% interest for x amount of months, but that is for next week as well.
For what we are talking about today, I strongly encourage you to always pay your statement balance. If you only ever pay the minimum balance, or any amount less than the statement balance, you are essentially getting charged more for your purchases. In some cases you'll pay for things multiple times over. Credit card interest rates are the highest of any loan I've ever seen. If you intend on opening a credit card account and not paying the full statement balance each period, from a financial perspective I urge you not to open one.
You will also see your total balance. This muddies the water as well, because if you pay your statement balance on the due date of your bill, your total balance by that time will probably be higher. That is okay. You do not need to pay your full balance to avoid interest, you just need to pay your statement balance by its due date. In fact, time value of money would say you shouldn't pay the full balance since you are better off hanging onto that money and investing it until it is owed, but that's a totally different concept altogether.
So you'll see three amounts at a given time for a single credit card. The total balance is the statement balance and then every other purchase you've made since the end of your last statement. Your statement balance will be what you need to pay off to avoid interest. And the minimum payment amount is what you need to pay to avoid your credit score from decreasing. Again, I urge you to pay your statement balance, by its due date, every time in most circumstances.
Why Is It Important To Use a Credit Card?
If there are all these risks involved with a credit card, why should I use one? While it is the easiest way to destroy your credit score by not making your payments in time, it really is the easiest way to build your credit score. If you treat your credit card like a debit card, and only accumulate purchases that you can back up with your bank account balance, and make your payments on time, then your credit score will increase.
Credit is important for a lot of things. Some people think it is only if you are looking to buy a car or a house, but that's not true. There are a lot of other times your credit is pulled, even just if you want to rent an apartment. So using a credit card responsibly and paying the statement balance each time is the best way to increase your credit score and get all of the bonuses and rewards we will discuss in Part 2 of this topic next week. Stay tuned!
