Congratulations! You are about to apply for your first credit card! Having heard about how great a credit card can be, and the importance of building credit, you decided to do some research. You saw fancy things like “0% interest for the first year” and “2% cashback on purchases” that sound like a great deal, but what does it all mean? Whether you are going into college and getting your first credit card, or deciding now is the time to build your credit, you have come to the right place. As I currently write this, I am 18 years old. This is about the recommended age to open a credit card. This guide will help you understand basic credit card terms, and how you can start building your credit score today!
The Dangers of Credit Cards
If used properly, credit cards can be one of the best tools for your financial success. Having a good credit score can give you a number of advantages in life. Lower interest rates on loans/credit cards, easier loan approval, and even deals on car insurance rates can all result from having a great credit score. However, it takes work to maintain a good credit score. According to The Balance, the average American household has around $7,800 of credit card debt. With the average credit card interest rate being 18%, to pay off that $7,800 in five years, it would cost you $4,110 in interest.
The truth is that most people can’t pay off their credit card in that timeframe. This means that as time goes on, you are paying more and more in interest. Credit card debt is a lot like quicksand, once you are in deep it is very difficult to get out! Tricky terminology, complicated rates, and an inability to budget can lead to mountains of credit card debt. We are going to simplify the credit card language, teach you what a credit score is and how it works, and the right time to open a credit card. When it is time to start using a credit card, you will be well on your way to an amazing credit score and financial wellness, possibly saving you thousands in the long run.
Common Credit Card Terms & Meaning
There are many terms and acronyms you probably have heard of, but may be confused about. You should know these basic terms before you open a credit card. Credit card companies use these terms, making them very important for your success. Understanding these terms will help you decide which credit card company you want to go with so you can get the best card that works for you. Here are just a few common credit card terms and their meaning, according to CNBC.
APR (Annual Percentage Rate)
Annual Percentage Rate, or APR, is one of the most common credit card terms and also one of the most challenging to understand, especially since it can change based on a number of factors. There are also many different types of APRs. When you first sign up for a credit card, you will probably have an introductory rate. Introductory rates are still an APR, but it is often less than the normal APR. This is what companies will show you in commercials to entice you to open a credit card. The introductory rate will most likely last you for six months to a year. After that, it will spike back up to the normal APR.
APR only matters if you have a balance on your credit card. If you pay off your balance every month, you will not have to pay interest. There are fixed and variable APRs. If it is fixed, it won’t move up or down. If it is variable, it will go up and down based on the prime rate. Essentially the prime rate is the best rate that lenders can charge their consumers. This rate is based on the economy. If the economy is doing well, the interest rate will be lower and vice versa.
Another thing about APR is even though it means Annual Percentage Rate, you will pay it every day in little segments. Meaning if your APR is 24%, every day you will be charged 0.065% interest on your debt. This is not in your favor because the interest is compounding. There are also APR rates for Balance Transfers, Cash Advances, Penalties, and Purchases. Make sure you look at all of these when you are looking for a credit card.
Your credit card balance is the amount you owe to the credit card company on your account. It includes the purchases, cash advances, fees, and interest. Keep in mind your current balance and statement balance may differ based on the billing cycle, purchases and payments made. Websites, such as Credit Karma, can often show you all of your credit card accounts and balances in one place, making it easier to evaluate your financial health.
The annual fee is the fee you will incur simply for owning the card. You will pay it one time every year. Some companies do not charge an annual fee, but it is important to know if your lending company does. When selecting your first credit card, it may be best to select one that has a $0 annual fee. Although you may have less rewards than a card with annual fees, it is a great way to save money and start working on your credit score.
Credit limit is the total amount of money you are allowed to charge on an account in a billing cycle. Once the credit limit is reached, you must pay off some of the principal balance to use the card again. For example, let’s say you have a credit limit of $5,000 and you spend all $5,000. You must pay off some of the principal before you can use that card again. A billing cycle lasts at least 21 days, and is normally about 30 days. Your credit limit depends on your credit score. The higher the score, the higher the credit limit you have. It is recommended that you only use between 30-40% of your credit limit, so you are able to pay it off fairly easy.
Every billing cycle, you are required pay a certain amount of the balance that is owed on the credit card. If you can pay off the entire balance at once, great! Sometimes you have to carry a balance to the next month. There will always be a minimum required payment to go toward the balance. If you fail to pay this minimum balance each month, you could have your rates drastically increased, costing you a ton of money! ALWAYS MAKE A MINIMUM PAYMENT!
This is the time between when the billing cycle ends and when the bill is due. Grace periods are always at least 21 days after the end of the billing cycle. No interest is charged during this time.
All of these terms can help to better understand how credit cards are used. One best practice to get into is looking at your credit card bill, and making sure you were charged the correct amount. Credit card companies make mistakes, and fraudulent charges may occur. This can save you money on charges you did not make, and is a great habit to further your financial understanding.
How My Credit Score is Calculated?
Credit score in a nutshell is telling lenders how trustworthy you are and the likelihood you will pay your bills on time. The most commonly used credit card scale is FICO. FICO’s credit card scale is a number tiered scale that rangers from 300-850. The higher your FICO credit score, the more lenders will trust you to pay back the money you borrow. This can result in better interest rates, less money down on bigger expenses, and can save you money in the long run. The table below breaks down the tiers to better understand where you stand from a lender’s perspective:
According to Money, Credit score is calculated by a weighted tiers. Your payment history accounts for 35% of your credit score. If you pay off your bills on time every month you will have a higher score than people who don’t. How much you owe makes up an additional 30% of your credit score. This includes loans as well. The more money you owe, the lower your score is.
Next, length of credit history is the third highest percentage at 15%. The longer you have had a credit card means that you will earn more points in this category. However, this category is relatively small, so while it is worth some points, it won’t be as big of a factor as paying off debt, or payment history.
The last two categories each make up 10% of your credit score. These categories are new credit, and types of credit used. New credit is how many new credit cards you have or have applied for. If you keep maxing out credit cards and try to open more cards, your score will go down. Having different types of loans is good to have on your credit score. It shows lenders diversity in your spending. If you only have one type, your credit score may go down. This may sound unusual that it is better to have more loans, than to not have them. However, according to FICO, this category is only worth 10% of the overall total.
How Do I Maintain a High Credit Score?
The key to maintaining a high credit score is to take financial responsibility and put effort into developing a plan. Budgeting your money so you are able to pay your bill on time is the number one way to have a high credit score. Having a large balance on your credit card is very bad financially because it lowers your credit score, costs money in interest, and increases your interest rates on loans. A helpful tip is to put the bill on auto pay for each month to ensure your bills are being paid! It is also recommended that you review your monthly credit card statement to make sure that everything is accurate.
The next tip that I recommend is to have some other credit cards, but not too many. Meaning that it is good to have more than one credit card, but five or six cards is probably too many. It is recommended to have two or three cards to show lenders you are spending, but not living beyond your means. Also, you should not apply for any additional cards unless you are absolutely sure that you need one.
When you apply for a credit card and lenders check your credit, this appears as an inquiry on your credit report. Even if the loan is declined, all inquiries stay on your report for 2 years, but impact your credit score for 12 months. If you have too many inquiries, it will possibly make your score plummet. As you can see, there is a number of ways to improve your credit score, but the best way is to make your payments on time every month.
When Should I Open a Credit Card?
18 is the recommended time to get a credit card. The reasoning behind this timeframe is that it gives you time to build up credit so when you come out of college, you have a good score. That is good if you know how to spend money responsibly during college. Unfortunately, many college students do not know how to spend money properly and the results can really lower their score. It also doesn’t make sense because in the FICO credit score 35% of your credit card comes from paying your bill on time, and 30% comes from how much you owe. That is over half of your credit score. Length of credit history only makes up 10% of your FICO score.
If you can manage your finances and pay your bills on time, I would recommend opening a credit card around age 18. However, if you think you are going to have trouble spending the money correctly, I would not advise that. Instead, wait until you feel that you can maintain financial responsibility.
When it comes to credit cards, it can feel like a confusing maze, with all of the different terms, score, and rates. However, if you put some time and effort into your credit, you will do fine. There are always ways to fix your credit, but waiting too long to do so could cost you dearly. Do what is best for you and your circumstances. If you don’t feel sure about it, talk to a financial specialist. Your credit is nothing to fool around with. It can be one of the best things for you, or one of the worst things for you. If you ever need help with your credit, contact a credit specialist. Their expertise will keep you out of the quicksand and on to a solid financial future to success.
Belco can help set you up with a credit card that is right for you! With no annual fees, a 12-month intro rate, and the same rate for purchases and cash advances, plus incentives like Belco Rewards, it is the perfect credit card to start on your financial journey. Learn more about our Visa Credit Cards, and believe in a better credit card with Belco!