Credit and Credit Cards

Credit cards are actually a type of loan. In exchange for lending you money (here called “credit”), credit card companies charge you high interest (usually around 20% APR) and fees (annual fees, late fees, over limit fees). Credit card loan interest rates are often nearly five times as high as home loan interest rates.

Credit cards should be looked at as a kind of expensive, short term, small loans. Generally, they are more expensive than regular bank loans because they come with higher interest rates and fees. Just like a bank loan, when you sign up for a credit card and use it to make purchases, you are making a binding legal agreement to pay off the debt. It will take a bankruptcy filing to wipe out the debt.

The balance on your credit card is what you owe. Generally, the balance includes the cost of what you bought, and if you did not completely pay off your balance from the previous month, interest on earlier charges. In addition, if you’ve missed a payment, your balance will also include a late payment fee (usually $35).

Credit card companies entice people (and especially students) to sign up for their credit cards with free swag, rewards points, or low or 0% introductory APRs. Many people are attracted to the fact that you only “have” to make a minimum monthly payment, which is usually $20 to $30 depending on your total balance. This is exactly what the credit card companies are hoping you will do, because they can charge high interest rates on the remaining balance. In exchange for the swag, rewards points and minimum payments, however, many students get sucked into spending more than they can afford, and paying huge amounts of interest in the long run.

For example: Let’s assume you have a credit card with an Annual Percentage Rate, APR, of 21% and a minimum payment of 2% of your balance. If you have $5,000 in credit card debt now and you make only the minimum payment each month, you’ll pay more than $37,000 over 50 years. And that’s assuming you don’t rack up additional debt beyond the $5,000, you aren’t charged additional fees, and your interest rate doesn’t go up.

If you must use a credit card, stick to these tips:

  • Don’t put more on your credit card than you have cash to spend in your bank account. This will ensure that you pay off your balance every month and are not charged interest.
  • Keep track of the money you spend on your credit card and have a plan to pay it off as soon as you are able. The longer you take to pay it off, the more it will cost you.
  • Know your interest rate, and know that introductory interest rates of low or zero percent inevitably will go up.
  • Know there are different APRs for different types of credit card transactions, such as purchases, balance transfers and cash withdrawals. Generally, interest rates on cash withdrawals are higher, and begin accruing from the date you withdraw the money, not from the date your balance is due.
  • Carrying a credit card balance over 25% can hurt your credit rating. (The 25% number is subject to change).
  • Don’t miss your payment due date – The late fees are very costly. Also, some credit cards will raise your APR once you’ve missed a payment.

Know your credit limit so you can stay within it. If you go over your limit, you’re hit with an over-limit fee and your interest rate can go up, making your total debt higher. Stay below your limit.

On to the next section!