- To best talk about credit cards we start by comparing them to debit cards
- The main difference between the cards lie in where money is withdrawn from
- While credit cards have benefits, you should only use them if you are able to pay your bill on time and consistently
- Not paying credit card bills on time will result in pretty large interest charges
- Acquiring some kind of debt, puts you in the system to start receiving a credit score
- A credit score is designed to tell the bank how likely you are to make timely payments
- The most important thing about credit cards is ensuring timely payment of bills
All About Credit Cards and A Little About Debit Cards
What is a credit card and how is it any different than a debit card? Growing up I always thought all of those plastic little cards were all just called “credit cards” and if I had one then basically I was officially an adult. That is soooo not the case, though. Repeat after me: Not all plastic cards are created equal.
Here’s the major difference: it all comes down to where the money is being taken from. A debit card pulls money directly from your bank account. A credit card borrows money from the bank to pay for your purchases. You then have to pay the bank back by a certain due date. If you don’t pay that money back in time, your bank will charge you interest. This is called an “annual percentage rate” or APR. That means you owe the amount you used (the balance) plus extra interest they charge for letting you borrow that money. Translation: they take MORE of your money.
Debit cards are more reflective of the money you actually have, it’s a less abstract than credit cards. But if you’re like me, and you’re slowly starting to realize the reality of adulting, then credit cards are an important part. FYI: As you pay back your credit card bill, a credit score is created for you in the big wide web of the financial industry (it’s why you have to give your SS# to open a card) and begins to build, but we’ll talk about that more in just a second.
A Nav.it Catch about credit cards: watch out for minimum payments versus payments in full. The banks make more money if you use your credit card and then DON’T pay off your balance in full each month because they charge you that interest we just talked about on the balance. The interest they charge you compounds on itself and therefore increases very quickly if you’re not paying attention.
So while it’s necessary to ALWAYS pay your minimum payment on time in order to have a good credit score (more below), it is also important to pay the whole balance. If you’re not paying the entire balance off every month, the bank charges you extra money because you borrowed their money and haven’t paid them back yet. Make sense? So in order to not owe the banks more than what you borrowed, paying off your credit card each month is essential.
As you can tell, we don’t love debt at Nav.it, because debt means you’re losing more of your hard earned money. This means trying to pay off credit card balances every month is most ideal. However, if you can control your spending and consistently pay your bill in full and on time, then you can look at credit cards as just a reality in our adulting world that have some pay offs.
How Credit Cards Influence Your Credit Score
We’ve established the basic definition of a credit card and how it’s different than a debit card in terms of where the money is coming from, but what else is different about credit cards? How are credit cards related to credit scores and how can we make sure we are leveraging our knowledge in a way that’s going to end up helping us instead of hurting us?
A credit score is designed to tell the bank how likely you are to pay back the money you borrow on time.
Since the bank would like to be paid back the money you borrow, on time and consistently, credit scores were designed to assess a borrower’s pattern of paying their debts. The higher the score the more likely you are to pay the minimum balance of your credit card bill, your rent, your student debt, etc on time. Financial institutions that loan you that money don’t like taking risks, and so the higher the credit score the more likely they are to give you access to their money through credit cards, loans, etc. The higher the score, the lower the interest rate they will charge you on that debt too. If you’ve never used credit, you don’t have a good credit score because you have no track record for them to assess.
Of course, there are other things that determine your credit score, besides just your payment history. This includes the types of credit you have, how many new accounts you’ve opened, total amount of money you used, and the how long your credit history has existed for.Banks are looking for consistency here, that you have used credit, you’ve paid the minimum balance regularly and paid off your loans in entirety on time.
As you can see, there are a number of things to think about when deciding whether a credit card is right for you. Assessing what kind of spender you are and how timely you will be paying your bills is key (and to plan how you organize your bill paying process monthly!–autopay, checks, etc).
Also, if you are an avid online shopper, one thing to recognize about credit cards is that online shopping is more secure. In the case of fraud or theft, banks will take the responsibility in reimbursing the charge. In addition to that, you need to keep in mind the record of a credit score, which will only begin to build after you have a credit card, or some kind of debt. For example, student loans or car purchases and payments can also determine credit scores.
Of course, this does not mean that you should get rid of your debit card. You can still use your debit card whenever you see fit– and if you want to take cash out of your bank, you should definitely used your debt card for ATMs and cash back on purchases. If you can avoid it, never, never take a cash advance from your credit card, they charge you even HIGHER interest rates on cash then on the principle balance of your credit card–i.e. Even more money you owe).
Good luck nav.ing credit cards–they are one of the most important parts of personal finances to make sure you understand and always pay off on time!
Image Credit: Mirjana Jesic