7 things you must know about credit cards
By Erica Sandberg
How can you forge a positive and fruitful relationship with credit cards? By learning the basics before you apply for an account. Understanding the fundamentals -- from knowing which types of credit cards exist to the legalities of usage -- will help you charge wisely from the moment you receive that powerful piece of plastic.
1. There are lots of different types of cards to choose from. There are several varieties of credit cards: general purpose cards can be used anywhere, while private label retail cards can typically only be used at the issuing store or service station. Most general purpose cards are unsecured, meaning the issuer extends a credit line line based mainly on your credit history. Secured cards, conversely, are backed by funds you put in a deposit account that the creditor can claim if you default. Because creditors assume little risk with secured cards, qualification is relatively easy, so they are ideal for those with damaged or unestablished credit. Robert Manning, professor of consumer finance and director of the Center for Consumer Financial Services at the Rochester Institute of Technology, recommends asking the issuer if an unsecured card will be available once you build your credit history. "Make sure they report to the credit bureaus, too," he says. If they don't, you won't be building a history at all.
2. There's no perfect number of credit cards you should have. According to myFICO.com, the consumer division of the company that invented the FICO credit risk score, the average consumer has nine credit cards. There is no perfect number of credit cards one "should" hold. A couple of general-purpose cards suit most consumers' needs. If you want a retail card, make sure it's for a store you frequent often, and offers an incentive for using it as retail cards typically charge higher interest rates than general purpose cards.
3. You must understand your card's interest rates. Credit card interest rates can range dramatically -- from 0 percent, limited-time balance transfer offers to as high as 30 percent. Creditors use such factors as your credit score, income, assets, current debt load, credit inquiries, payment history and economic conditions to set your annual percentage rate (APR). Who receives the best (lowest) rates? Consumers with positive and proven credit histories
4. Comparing cards is vital. Banks, credit unions, retailers, and credit card companies all issue credit cards. (Visa and MasterCard are companies that help process payments; they don't issue cards.) The best way to apply for an account, says Lita Epstein, author of "The Complete Idiot's Guide to Improving Your Credit Score," is to "locate the card with the best rates and terms by researching options online." This targeted search approach can protect your credit rating from too many unnecessary inquiries.
5. The contract is binding. Read the agreement carefully, because once you sign, you form a legal contract and consent to the terms set by the issuer. These include:
- Credit line/limit. The total amount you may charge, including interest and fees.
- Annual percentage rate (APR). The interest charged on carried-over balances. It usually stipulates a higher rate for paying late, charging beyond your limit, balance transfers, and cash advances, too.
- Interest calculation method. Most calculate interest charges by averaging the daily account balance, then multiplying that figure by the periodic rate (APR divided by the number of days in a year).
- Fixed or variable APR. Fixed rate APRs have consistent interest rates. Variable APRs are tied to an index (often the prime lending rate, which is set by the Federal Reserve) and thus fluctuates.
- Grace period. The grace period is the number of days (generally between 20 and 30) you have to pay in full before interest accrues.
- Fees. Ordinary fees include those for cash advances, balance transfers, paying late, exceeding your credit limit, and sometimes an annual fee. Avoid cards with nonstandard fees, which Manning lists as application charges, not using the card, calling the creditor if they don't have an 800 number, online account management, and terminating the account.
Be aware that most creditors reserve the right to change any of these terms -- so check your mail vigilantly for adjustment notices.
6. You can pay in full...or not. Each time you charge, you borrow money. However, because credit cards offer a revolving balance option, you aren't required to pay the entire loan -- as long as you make at least the minimum requested payment, you can carry the remainder over to the next month. Interest will be added to the balance. Avoid paying just the minimum payment though. "Your creditor may consider you to be high risk, and increase your interest rate accordingly," warns Manning
7. You have rights. As a cardholder, you have a legal right to fair treatment. The Truth in Lending Act requires issuers explain all the terms of the contract in detail, in language the average adult can understand. Problems with your bill? The Fair Credit Billing Act gives you the right to dispute and correct errors, and protects your credit rating during the process.
Ultimately, there is no secret to using credit cards wisely. If you get a low-fee account, always pay on time, and carry no debt from month to month, charging is free. Even better, if your card has a good rewards program, you can even come out ahead by using them.
CREDIT CARD HELP: The basic fundamentals of credit cards