Understanding Credit Cards 101

The majority of people that get caught in financial traps by using credit cards don’t really understand how credit cards work.  They view the credit card as a little plastic checkbook that they can buy goods with now, and pay later.  However, the key to using a credit card responsibly is to understand how it actually works.  

Lenders that provide credit cards make money off of you when you have to pay them interest.  The amount of interest that they charge you is determined by either a fixed or variable annual percentage rate, which is also abbreviated as APR.  The interest rate of a credit that is determined by a fixed APR usually does not change much over time.  If it ever does change, lenders are required to notify you prior to changing it.  On the contrary, the interest rate determined by using a variable APR can fluctuate over time and the lenders are not required to notify you prior changing your APR.  Whether you already have a credit card or are applying for one, you may determine if the APR is going to be fixed or variable by reading the terms and conditions of the card.         

Another key to understanding credit cards and using them responsibly is to understand what a grace period really means.  A grace period is not always the same for every card and can be quite confusing even for savvy credit card users.  It is the total length of time, usually in days, that you have to pay off your balance before you are charged interest on your new purchases.  Sometimes it is a fixed amount of days, other times it is only the days left until your billing cycle closes.  However, if you have a balance carried over from the previous month and are currently being charged interest, then you typically do not get a grace period for new purchases.  The individual grace period for every card can be found in the terms and conditions of the card.  It may also appear on your statement each month. 

Every card has fees associated with it, but not every card has the same fees.  Sometimes there is an annual fee assessed to your credit card.  This is paying just to have the privilege to use the card; however these cards usually have very special perks associated with them.  Some cards allow cash advances and have an associated fee cash-advance fee.  The actual fee assessed is typically the greater of either a fixed fee or a calculated percentage of the cash advance, and sometimes it’s a combination of both methods.  Other cards also allow balance transfers and assess balance-transfer fees in a similar manner to the cash-advance fees.  Almost every card will assess a late-payment fee anytime the lender receives a late payment, or a payment that is lower than the minimum payment due even if it is on time.  If you have a credit limit, you will almost always be assessed an over-limit fee when you exceed the maximum stated limit. 

Most lenders that provide credit cards will often offer perks to entice you to use their particular card over a competitor’s card.  These perks come in many different forms, but the most frequent perk offered is points awarded per dollar spent.  The points are basically a form of rebate on purchases made issued by the lender.  Depending on the card and terms, the points can then be transferred back into real money in the form of a check, gift card, or even as a payment on your card.  Other common perks that may be offered include hotel and restaurant discounts, rental car coverage, frequent flier miles, and accidental travel and life insurance.  Most credit cards now also offer special coverage that may be purchased which pays your minimum payment due in the event that you ever become unemployed for a period of time or disabled.