An Introduction to Credit Cards

Published Fri, May 1 2020 at 10:22 PM PT
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By Obioha Okereke

When it comes to buying a car, renting an apartment, or buying a house, there is one common thing that sellers always look at…your credit score. If you don’t have an established credit history, or you have a low credit score, this can hurt your chances of being approved for loans, and your ability to receive favorable terms on interest rates.

What is Credit?

Using credit is a process where you buy something, or borrow something, with the guarantee that you will pay for it in the future. For instance, using a credit card, you can purchase groceries, gas, and other items. Instead of having money withdrawn from your checking account, the money used to purchase those goods is charged to your credit account. Within 30 days of your purchase, you must then pay for any items you charged to your card or else you will incur fees.

It is important to note that when you use a credit card to make a purchase, money is not withdrawn from your accounts because you are borrowing money. Your credit account will instead show a charge that you do not have to pay immediately. This is where most people mess up.

Credit IS NOT Free Money

Because you do not need to immediately pay for items charged to a credit card, many people will relentlessly charge items to their card. It is important to realize that you still have to pay back this money and most times, you must do so within 30 days.

Unfortunately, for a variety of reasons, most people don’t fully understand credit and end up borrowing too much money and going into debt. Even worse, some do not pay their minimum payments and can see their debt go into collections, or have their wages garnished.

Getting Started Building Credit

Once you’ve applied for a credit card, and you’ve been approved, you can get started building credit! When approved, the card issuer will approve a credit limit — the maximum amount of money you can charge to a card. Your credit limit will be based on your current income, outstanding debt, and your current credit history.

To open a credit card, you must be at least 18 years old. If you’re below the age of 18, your parent(s) can add you as an authorized user on one of their cards to help you grow your credit score. If you’re opening your first card, and you’re a student, you may be eligible for a student credit card.

Check out Nerdwallet’s Best College Student Credit Cards

What is A Good Credit Score?

Generally speaking, you want to keep your credit score above 700, but always be aiming to get it above 800.

The most important factors to building an amazing credit score are credit card utilization, and your ability to make regular payments. Credit card utilization is a measure of how much you’re charging to your card. If you have a credit limit of $500 and you spend $100, that represents 20% utilization.

Try to avoid exceeding 30% on a credit card or there will be a negative impact to your credit score. This does not mean you shouldn’t use your card though. If you neglect to charge items to your credit card on a regular basis, you may start to see your score slowly decline.

Avoiding Common Mistakes

Use a credit card to purchase items that you can afford, or know you will be able to pay off in the short term. It may seem contradictory but if you use a credit card for items you don’t have enough money to purchase, how do you expect to pay off the debt?

More importantly, do not use a credit card to fund a lifestyle that you can’t maintain — you may find yourself maxing out cards, and getting into massive debt. A good example of how to use a credit card is to pay for groceries, flights, travel expenses, and large one off purchases like a TV.

When paying off your credit card, it is recommended that you pay off the entire balance every month. If possible, you should pay off the credit balance before it is due. Making regular payments is the most important factor in establishing a strong credit score.

Not only can having debt be mentally stressful, it can have financial impacts as well. To avoid getting into trouble with credit card debt, avoid the following:

• opening multiple credit card accounts (and if you do, don’t max them out)

• failing to pay off debt, and carrying a balance

• exceeding a utilization rate of 30%

• maxing out your card(s)

• taking out a cash advance

• missing a minimum payment

All of the above are sure to reduce your score and are some of the mistakes most commonly observed among individuals who have poor credit scores.

When utilized correctly, a credit card can be a great tool for establishing financial freedom and security. With a higher credit score, you can easily be approved for larger loans and receive low interest rates. You won’t be required to place a large down payment on big purchases like cars, and houses.

You’ll be extremely satisfied once you find that the work you put into establishing excellent credit, enables you to borrow money and make large purchases with ease.

Check out CNBC’s 10 Most Common Credit Card Mistakes