10 things you need to know about credit cards

Credit cards are ubiquitous in the modern financial landscape, offering convenience, rewards, and financial flexibility. However, they also come with complexities and risks that can be daunting for both new and experienced users. This comprehensive guide answers the ten most frequently asked questions about credit cards, providing detailed information and insights to help you make informed decisions.

1. What is a Credit Card and How Does it Work?

Definition and Basic Functionality:
A credit card is a payment card issued by financial institutions that allows cardholders to borrow funds to pay for goods and services. The amount borrowed must be paid back with interest if not repaid in full by the due date.

How It Works:

• Credit Limit: The maximum amount a cardholder can borrow, determined by the issuer based on creditworthiness.
• Purchases: When a purchase is made, the credit card company pays the merchant, and the cardholder’s available credit is reduced by the purchase amount.
• Billing Cycle: The period during which purchases are recorded, usually lasting about a month.
• Statement Balance: The total amount owed at the end of the billing cycle.
• Minimum Payment: The minimum amount that must be paid by the due date to avoid penalties.
• Interest Charges: If the full statement balance is not paid, interest is charged on the remaining balance.

Benefits of Using a Credit Card:

• Convenience: Easy to carry and use for online and in-person transactions.
• Rewards: Many cards offer cash back, points, or miles for purchases.
• Security: Enhanced protection against fraud compared to debit cards.

Example:
If your credit limit is $5,000 and you make a $1,000 purchase, your available credit drops to $4,000. If you pay off the $1,000 before the due date, no interest is charged, and your available credit returns to $5,000.

2. How Do Credit Card Interest Rates Work?

Understanding Interest Rates:
Interest rates on credit cards are typically expressed as an annual percentage rate (APR). The APR includes both the interest rate and any fees that are charged annually, making it a comprehensive measure of the cost of borrowing.

Types of APR:

• Purchase APR: Applied to purchases made with the card.
• Balance Transfer APR: Applied to balances transferred from another credit card.
• Cash Advance APR: Applied to cash withdrawals using the credit card, often higher than the purchase APR.
• Penalty APR: Higher rate applied if you miss a payment or violate other terms.

How Interest is Calculated:
Interest is usually calculated daily using the daily periodic rate, which is the APR divided by 365 days. The interest for each day is added to the balance, leading to compound interest if the balance is not paid off.

Avoiding Interest Charges:

• Grace Period: The time between the end of the billing cycle and the payment due date. No interest is charged if the full balance is paid within this period.
• Paying in Full: Avoid interest by paying the full statement balance each month.

Example:
If you have a balance of $1,000 and an APR of 18%, the daily periodic rate is 0.0493% (18%/365). Interest for one day is $0.49 ($1,000 * 0.0493%), and this amount compounds if not paid off.

3. How Do Credit Card Rewards Programs Work?

Types of Rewards:

• Cash Back: Earn a percentage of your purchases as cash.
• Points: Earn points for each dollar spent, which can be redeemed for travel, merchandise, or statement credits.
• Miles: Earn miles that can be redeemed for flights, hotel stays, and other travel-related expenses.

Earning Rewards:

• Flat Rate: Earn a consistent rate on all purchases (e.g., 1.5% cash back on all purchases).
• Tiered Rate: Earn different rates based on spending categories (e.g., 3% on groceries, 2% on gas).
• Bonus Categories: Higher rates on specific categories that change periodically.

Redeeming Rewards:

• Cash Back: Direct deposit, check, or statement credit.
• Points: Redeem through the issuer’s portal for various rewards.
• Miles: Redeem through airline or travel portals.

Maximizing Rewards:

• Sign-Up Bonuses: Meet spending requirements to earn large bonuses.
• Strategic Spending: Use cards with higher rewards for specific categories.
• Combine Programs: Use multiple cards to maximize rewards across categories.

Example:
A card offers 2% cash back on groceries and 1% on all other purchases. Spend $500 on groceries and $1,000 on other items, earning $10 (2% of $500) + $10 (1% of $1,000) for a total of $20 cash back.

4. How Do You Build and Maintain a Good Credit Score with a Credit Card?

Building a Credit Score:

• Timely Payments: Pay at least the minimum amount due by the due date to establish a positive payment history.
• Low Credit Utilization: Keep your balance below 30% of your credit limit.
• Long Credit History: Maintain older accounts to lengthen your credit history.

Maintaining a Good Credit Score:

• Avoid Late Payments: Set up automatic payments or reminders.
• Monitor Your Credit Report: Check for errors and signs of fraud.
• Limit New Credit Applications: Too many applications in a short time can negatively impact your credit score.

Factors Affecting Credit Score:

• Payment History (35%): Timeliness of payments.
• Credit Utilization (30%): Ratio of your credit card balances to your credit limits.
• Length of Credit History (15%): How long your credit accounts have been open.
• Credit Mix (10%): Variety of credit accounts (e.g., credit cards, loans).
• New Credit (10%): Recent credit inquiries and new accounts.

Example:
If you have a credit limit of $10,000 and a balance of $2,000, your credit utilization is 20%. Paying your bill on time and keeping utilization low helps maintain a good credit score.

5. What Are the Different Types of Credit Cards Available?

Types of Credit Cards:

• Standard Credit Cards: Basic cards with no rewards or special benefits.
• Rewards Credit Cards: Offer cash back, points, or miles for purchases.
• Secured Credit Cards: These require a security deposit and are ideal for building or rebuilding credit.
• Student Credit Cards: Designed for college students with lower credit limits and rewards.
• Business Credit Cards: Tailored for business expenses with higher limits and business-specific rewards.
• Travel Credit Cards: Offer travel-related benefits such as miles, travel insurance, and airport lounge access.
• Balance Transfer Credit Cards: Low or 0% introductory APR on balance transfers to help pay off debt.

Choosing the Right Card:

• Spending Habits: Select a card that rewards your typical spending categories.
• Credit Score: Ensure your credit score meets the card’s requirements.
• Benefits: Consider additional benefits like travel insurance, purchase protection, and extended warranties.
• Fees: Be aware of annual fees, foreign transaction fees, and late payment fees.

Example:
A frequent traveller might choose a travel rewards card like the Chase Sapphire Preferred, which offers 2x points on travel and dining and comes with travel insurance and no foreign transaction fees.

6. How Do Balance Transfers Work on Credit Cards?

Definition:
A balance transfer involves moving existing debt from one credit card to another, typically to take advantage of lower interest rates or promotional 0% APR offers.

How It Works:

• Apply for a Balance Transfer Card: Choose a card with favourable terms for balance transfers.
• Transfer the Balance: Provide information about the existing debt to the new card issuer, who will transfer the balance.
• Repay the Debt: Make payments to the new card issuer under the new terms.

Benefits:

• Lower Interest Rates: Reduce the amount of interest paid over time.
• Simplified Payments: Consolidate multiple debts into one payment.
• Debt Repayment: Pay off debt faster by taking advantage of 0% APR periods.

Costs and Considerations:

• Balance Transfer Fee: Typically 3-5% of the transferred amount.
• Promotional Period: Ensure you can pay off the balance before the promotional rate expires.
• Impact on Credit Score: A new application and higher credit utilization can temporarily affect your score.

Example:
If you transfer $5,000 to a new card with a 0% APR for 12 months and a 3% transfer fee, you’ll pay $150 in fees ($5,000 * 0.03). By paying $417 monthly, you can pay off the balance within the promotional period.

7. What Should You Look for in a Credit Card Agreement?

Key Terms to Understand:

• APR: Annual Percentage Rate for purchases, balance transfers, and cash advances.
• Fees: Annual fees, late payment fees, foreign transaction fees, and balance transfer fees.
• Grace Period: Time to pay off the balance without incurring interest.
• Rewards Program: Details of how rewards are earned and redeemed.
• Penalty Rates: Higher interest rates that apply if you miss payments or exceed your credit limit.
• Credit Limit: Maximum amount you can borrow on the card.

Reading the Fine Print:

• Introductory Offers: Check the duration and terms of any introductory APR or sign

-up bonus offers.

• Changes to Terms: Understand how and when the issuer can change the terms of the agreement.
• Payment Allocation: How payments are applied to balances with different APRs.

Red Flags:

• High Fees: Look out for high annual fees, especially if the benefits don’t justify the cost.
• Complicated Rewards Programs: Ensure you understand how to earn and redeem rewards.
• Short Grace Periods: A shorter grace period can lead to unexpected interest charges.

Example:
A card with a 15% APR, a $95 annual fee, and a 3% foreign transaction fee may be suitable for domestic use with high rewards but less ideal for international travellers.

8. How Do You Protect Yourself from Credit Card Fraud?

Preventative Measures:

• Secure Your Card: Keep your card and account information safe. Don’t share your PIN or write it down.
• Monitor Statements: Regularly check your statements for unauthorized transactions.
• Use Secure Websites: Ensure online purchases are made on secure websites (look for “https”).
• Enable Alerts: Set up account alerts for transactions, payments, and suspicious activity.
• Use EMV Chips: Prefer cards with EMV chips for enhanced security over magnetic strips.

What to Do If You’re a Victim:

• Report Immediately: Contact your card issuer as soon as you notice suspicious activity.
• Freeze Your Account: Temporarily halt transactions to prevent further fraud.
• Dispute Charges: File a dispute for unauthorized charges with your card issuer.
• File a Report: Report the fraud to the Federal Trade Commission (FTC) and local law enforcement.

Additional Tips:

• Use Virtual Cards: For online transactions, use virtual card numbers provided by some issuers.
• Strong Passwords: Use strong, unique passwords for your online accounts.
• Two-Factor Authentication: Enable two-factor authentication for additional security.

Example:
If you notice a $200 charge at a store you didn’t visit, immediately contact your issuer to report the fraud, freeze your account, and dispute the charge.

9. What Are the Pros and Cons of Using a Credit Card?

Pros:

• Convenience: Easy to use for online and in-person transactions.
• Rewards: Earn cash back, points, or miles for purchases.
• Security: Enhanced protection against fraud and unauthorized transactions.
• Credit Building: Responsible use helps build and improve credit scores.
• Grace Period: Time to pay off purchases without incurring interest.

Cons:

• High Interest Rates: Carrying a balance can lead to significant interest charges.
• Fees: Annual fees, late payment fees, and other charges can add up.
• Debt Risk: Easy access to credit can lead to overspending and debt.
• Impact on Credit Score: Late payments and high credit utilization can negatively affect your score.
• Complexity: Managing multiple cards and understanding terms can be complicated.

Example:
Using a card with a generous rewards program can earn valuable points, but if you carry a balance with a high APR, interest charges can negate the benefits.

10. How Can You Effectively Manage Credit Card Debt?

Strategies for Debt Management:

• Pay More Than the Minimum: Reduce principal faster and save on interest.
• Balance Transfers: Move high-interest debt to a card with a lower rate.
• Debt Snowball Method: Pay off the smallest debts first for quick wins.
• Debt Avalanche Method: Focus on paying off the highest-interest debt first to save money.
• Budgeting: Create a budget to manage expenses and allocate more funds to debt repayment.

Avoiding Future Debt:

• Limit Credit Card Use: Use cards for essential purchases only.
• Emergency Fund: Build an emergency fund to avoid relying on credit cards.
• Automate Payments: Set up automatic payments to avoid late fees and missed payments.
• Seek Help: Consider credit counselling or debt management programs if needed.

Example:
If you have a $5,000 debt on a card with a 20% APR, focus on paying more than the minimum payment each month. Using the debt avalanche method, prioritize this high-interest debt while maintaining minimum payments on other cards.

Conclusion

Credit cards offer numerous benefits, including convenience, rewards, and the ability to build credit. However, they also require careful management to avoid pitfalls like high-interest debt and credit score damage. By understanding how credit cards work, choosing the right card, and employing effective strategies for debt management and fraud prevention, you can make the most of your credit card while maintaining financial health.