How Credit Cards Work: A Beginner’s Guide to Credit Cards
Credit cards get a bad rep for being a dangerous thing. You may have even heard a dad or two warn their kids not to get involved with credit. In reality, this could not be further from the truth. If you understand how credit cards work, they can be a powerful tool for meeting your financial needs (not to mention some benefits on the side).
For beginners who may have just started working or have simply never had a credit card before, navigating the world of credit cards can be overwhelming. From understanding credit limits and interest rates, to managing monthly payments and avoiding debt, there is a fair bit to learn.
In this beginner’s guide to credit cards, we’ll try to provide a comprehensive overview of how credit cards work, including the common types of credit cards available and some rules you should follow when you get your first credit card (and any cards after that). By the end of this, you should be well on your way to conquering the world of credit…or your world at least.
Credit cards get a bad rep for being a dangerous thing. You may have even heard a dad or two warn their kids not to get involved with credit. In reality, this could not be further from the truth. If you understand how credit cards work, they can be a powerful tool for meeting your financial needs (not to mention some benefits on the side).
For beginners who may have just started working or have simply never had a credit card before, navigating the world of credit cards can be overwhelming. From understanding credit limits and interest rates, to managing monthly payments and avoiding debt, there is a fair bit to learn.
In this beginner’s guide to credit cards, we’ll try to provide a comprehensive overview of how credit cards work, including the common types of credit cards available and some rules you should follow when you get your first credit card (and any cards after that). By the end of this, you should be well on your way to conquering the world of credit…or your world at least.
How Credit Cards Work: The Basics
First, it’s important to understand what a credit card is. Much like the popular debit card, a credit card is a typical plastic card issued by banks to help you make purchases.
The way that they work is by allowing you to borrow money to make purchases. Every time you make a purchase with it, you’re not using your own money. You’re using the bank’s money. At the end of each month, you are required to pay back the borrowed amount. It’s as simple as that.
“Every time you make a purchase with it, you’re not using your own money. You’re using the bank’s money“
What Happens if You Don’t Pay It Back?
Now onto the dark side of credit cards – added interest fees. If you DO NOT pay off your credit card by its due date at the end of each month or whenever, and you carry that balance from one month to the next, the credit card company will charge you an additional fee on the amount you owe. Read this again if you didn’t fully understand it. It’s essential to know.
You’ll almost certainly come across the term ‘Annual Percentage Rate (APR)’. This is basically the cost of borrowing money on a credit card, expressed as a yearly percentage. The higher the APR, the more expensive it is.
“If you DO NOT pay off your credit card by its due date…the credit card company will charge you an additional fee“
For example, if your card has an APR of 20%, and you don’t pay off your balance, you’ll be charged 20% on your remaining balance over the course of the year. The worst part is, if you keep carrying over your balance, this damn interest will be added to your balance each month, so you end up paying interest on interest, which can add up quickly. Needless to say, we want to avoid this, so it is absolutely mandatory to pay off your balance in full each month. Some banks may even give you the option to pay 100% or 5% or 10% monthly. Always stick with the 100%
Difference Between Statement Date & Due Date
When you start using your card, you will come across your credit card statement, which is made available at the same day every month and basically lists all the purchases you made with your credit card for the previous month. The statement will tell you how much you need to pay back and by when (the due date). The due date is also the same every month.
“The statement will tell you how much you need to pay back and by when (the due date). The due date is also the same every month“
For me personally, my statement is released on the 25th of every month and it tells me all the purchases I made, the total amount and that the due date to pay off the credit credit, which is on the 20th of the following month. So i have just under a month to review all my expenses on the statement and make the payment by the 20th. Generally, banks offer an auto-payment feature to make this easier if you forget the dates.
What To Look For In a Credit Card
When looking for a credit card, especially your first one, there are several factors you want to check before pulling the trigger and applying for one.
Low (or no) Annual Fees:
Credit card companies generally charge an annual fee for cards, but fortunately nowadays, many cards are coming with no annual fees. If you don’t have a no annual fee option, go for one that isn’t too heavy on the annual fees.
Low APR:
From our discussion above, you shouldn’t be paying any interest fees in the first place right? By paying in full every month, you avoid this finance trap. Nevertheless, it is worth comparing the APRs of the available cards to make sure you don’t choose the one with a ridiculous APR.
Rewards:
Rewards are going to be the biggest reason you use credit cards over debit cards. Some offer cashback, some offer airline miles and others do good ol reward points which can be exchanged to various things.
The extent of how beneficial the rewards are would vary from country to country, but I personal prefer rewards points as they are versatile and be used for travel or shopping vouchers. Cashback usually gives lower rates compared to points and airline miles can be difficult to accrue and if you fly with various airlines, it can be tricky to accumulate enough points to get a free flight or business class upgrade.
Introductory Offers:
Most credit card companies will offer introductory incentives to get you to select their card, such as bonus points, miles or even an interest-free period. Don’t let this alone sway your decision, but consider it as an added bonus over the other essentials.
Additional Perks:
In addition to the rewards program, credit cards often include an array of other benefits as well including airport lounge access, travel insurance, extended warranties and credit protection.
Of course the better cards will have more perks, but you should choose a card that offers at least some of these to start.
Late fees
Much like APR, as a now educated gentleman on credit cards, you have no intention of paying late fees as you’ll be paying off your card in full every month. However, it is still worth checking that if for some reason, you miss out on a payment, you’re not left emptying your pockets just for a late fee.
Do keep in mind that you’ll likely see many cards available on the bank’s website or at the bank itself, including some swanky looking cards, but many of them will generally be for people with higher credit scores (if they apply in your country) or higher income brackets. So if you’re a beginner, you likely won’t qualify for them, but you can definitely work towards them within just a few years if you rules in the sections below.
Common Types of Credit Cards
There are a lot of credit cards in the market now, but the usual suspects that you’re likely to come across around the globe would be those provided by Visa, Mastercard and up to a lesser extent, American Express.
While every bank puts their own flair, design and even names on the cards, there are ultimately just a few tiers of each card, so I thought it best we give you a good initial understanding of the different cards that will probably be your main options.
As you can see, every credit card provider offers different tiers of credit cards (depending on your country). They are generally quite similar from one provider to the next, with each tier offering you a different set of benefits.Â
Pros and Cons of Credit Cards
By now you’ll probably have a good idea of what credit cards can do for you. While they do come with many benefits, they do have some downsides which you should be aware of before getting started.
Pros
- Safer than debit cards and cash as you are using the bank’s money, not your own
Rewards (points, cashback, miles etc.)
Airport lounge access
Accepted internationally (more so than debit cards) which makes it great for emergencies
Helps build and improve credit score
Provides purchase protection
Can provide international assistance for emergencies
Can provide travel insurance
Can provide extended warranties
Can allow for larger purchases to paid off over time
Cons
- High interest rates can be very costly
If not disciplined, can be tempted to overspend, especially if you have a high limit
Can have charges like annual fees
Poor spending habits can lead to accumulation of debt and poor credit scores
Building habits of good spending, statement monitoring etc. can be difficult for some
Can have late payment and over-limit fees
Why Credit Cards are Better than Debit Cards & Cash
A common question many people have is “Why are credit cards better than debit cards & cash?” Most people feel like credit cards are unsafe and very risky, but as you can probably tell from the pros and cons above, they’re only risky if you use them unwisely.
So to make things very clear, credit cards are in fact better than debit cards and cash for multiple reasons including:
- Rewards: Credit cards offer rewards such as cashback, points and/or miles that can be redeemed for various benefits. Debit cards do not offer such rewards.
- Accepted internationally: Credit cards are widely accepted internationally, making them convenient for travel and emergencies. Debit cards may have limited acceptance outside of your home country.
- Additional perks: Credit cards often come with additional perks such as airport lounge access, travel insurance, and extended warranties. Debit cards do not offer these perks.
- Building credit: Using a credit card responsibly can help build your credit history, which is important for future financial endeavors such as getting a loan or mortgage. Debit card usage does not impact your credit score.
- Purchase protection: Credit cards offer better protection against fraudulent charges compared to debit cards. If your credit card is stolen or used fraudulently, you are not held liable for those charges.
Overall, credit cards offer more benefits and security compared to cash and debit cards, making them a better choice for many consumers.
Credit Card Rules to Follow
Now that we’ve gone over the essentials of credit cards, from how they work to how they can benefit (or hurt) you. There are some essential rules that you absolutely must follow if you want to be financially smart and live a better life.
Rule #1:Â Pay Off Your Credit Card in Full Every Month
I’ve said it multiple times now. You absolutely must pay off your credit card in full every month in order to avoid those pesky interest fees. So long as you follow this one rule, you will not face any extra unnecessary fees and you can use your card pretty much freely without worrying and reap all the benefits that your card has to offer.
Rule #2: Keep Within Your Limits
Don’t overspend. Repeat after me. “Your credit card has a limit. Stay within it.” Don’t think of your available credit limit as extra money. Don’t overspend. Only buy what you can afford. You pretty much treat it like a debit card.
It should always be within your ability to pay the entire amount every month. You should always have that amount available in your bank current account ready to pay back.
If you’re well-disciplined and good with this, the bank can increase your limit. On the other hand, if you’re not, you should consider decreasing your credit limit.
“Repeat after me. Your credit card has a limit. Stay within it.“
Alpha Tip
As an elite male specimen, you work to be on top of your finances. So assuming you have a budget in place (check out our budget ideas here if you need one) and are regularly tracking your spending, nothing changes if you’re using a credit card. You mark that expense when you spend it. You consider it as money spent. Don’t wait till the following month’s credit card statement is released and you actually pay off the card. The money is spent when you make the purchase.
Rule #3: Check Your Statement Every Month
Even though you’re an A-list man who’s tracking their spending every month, you should always check your statement. Make sure you clearly remember what all those expenses were. Note the higher ones. For example, if most purchases are in double digits, take an extra look at the triple digit purchases.
If you notice any errors or suspicious activity, you can contact the bank and notify them before the payment due date so that they can look into it and fix it. It really does help to have your list of tracked expenses, so you can cross-check everything.
Rule #4: Avoid Using Most of Your Credit Limit (Sometimes)
Particularly for those countries implementing credit scores, using more than 30% of your credit limit can actually negatively affect your credit score. This is called the utilization ratio. The lower the utilization ratio, the better your credit score. Keep paying off your purchases regularly to maintain a low usage.
Conclusion
So there you have it. Credit cards really can be an incredibly useful financial tool if used wisely. Hopefully you find the world of credit cards simpler and less complicated now.
By understanding how credit cards work, selecting a good card and following some essential rules, you can make the most out of your credit card without paying a cent of interest fees.
Always remember to pay off your balance in full every month, have good spending habits and check your statement regularly.
So go forth my brother (or sister) and get your first credit card if you haven’t already. Enjoy all the benefits from your regular spending. Build up those points, earn yourself some free perks and live that luxury life you deserve.
Stay Wealthy Gentleman