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Whether you've been using credit cards for years or you're applying for your first one, they can be confusing. Depending on how you use them, credit cards can either be incredibly dangerous or immensely helpful. This guide will walk you through what you need to know about using a credit card, building credit and earning rewards.
How to use a credit card: The 4 principles to master
You should always handle credit cards with extreme care. Unlike debit cards, you're making purchases on credit — meaning you're 100% liable for paying back everything you charge to your credit card. If you aren't careful, you can end up in a lot of debt.
There are four main principles to becoming a credit card master. If you take away anything from this guide, you should always follow the first rule — pay your bill on time and in full every single month. This strategy alone will help your personal finances tremendously.
If you'd like to learn other ways to maximize your credit card use, read on for the best practices for managing your credit card.
Rule #1: Always pay your bill on time (and in full)
The most important principle for using credit cards is to always pay your bill on time and in full. Following this simple rule can help you avoid interest charges, late fees and poor credit scores. By paying your bill in full, you'll avoid interest and build toward a high credit score.
The consequences of missing a payment
By consistently missing payments, you could end up paying hundreds of dollars in late fees. The negative consequences spiral — once your credit score takes a hit, you could face thousands in interest when applying for future mortgages or loans. If you're unable to pay your bill on time, it may be time to cut up your card.
You're usually given multiple options to pay your credit card statement each month. While it may be tempting to pay just the minimum payment — which could be as low as $25 — you'll start to accrue interest, leading to years of debt. The best practice is to pay off your credit card bill as soon as you make a purchase. This way, you can get into the habit of paying your bill long before its due date.
Each month, your issuer will provide your credit card statement with two dates: the closing date and payment date:
- The closing date is the last day you can make a charge for a monthly statement. After the closing date, any new transaction will go onto next month's statement.
- The payment date tells you when the payment for a particular statement is due.
In the example above, this user has a closing date of Jan. 16 and a payment date of Feb. 13. This monthly statement ran from Dec. 17 to Jan. 16, with a payment due on Feb. 13. In this case, you have a 28-day grace period after your statement date before you're required to make a payment. You won't be charged any interest during this grace period as long as you pay in full by the due date.
All credit cards are different and will have varying billing cycles, payment dates and grace periods. Review the information for your credit card to understand how it works for your situation. If you're having trouble remembering to pay your bill, most issuers will allow you to set up automatic payments or schedule reminders each month.
Rule #2: Keep your balances low by only charging what you can afford
In addition to making on-time payments, it's essential to keep your balance low relative to your available credit limit. There are two main benefits to maintaining a small balance:
- Low balances help increase your credit score.
- You're more likely to pay off your balance in full and on time.
Many factors determine your credit score, but a significant portion (30%) comes from credit utilization. In other words, this is the ratio of what you owe to your total credit limit. For instance, if you have a credit limit of $1,000 and charge $500 to your card, your credit utilization would be 50%.
While there's no clear definition of your credit utilization, experts believe that you should keep it under 30%. Anything higher than that can decrease your credit score. To achieve a low credit utilization ratio, you should typically charge less than you can afford. By keeping a low balance, you minimize the chance that you'll spend more than you can pay off at the end of the month.
Finally, don't view your credit card as an extension of your budget. You should never charge more than what you can currently cover in your bank account. It's tempting to spend ahead based on what you know you'll get paid, but it's a bad practice. If you lose your job or run into an emergency, you won't be able to cover those charges. People don't intend on having credit card debt — it builds slowly and becomes a vicious cycle that becomes hard to break.
Rule #3: Understand how interest is calculated
Contrary to popular belief, interest isn't calculated based on the remaining balance after making a minimum payment. In reality, issuers calculate interest based on your average daily balance, calculated by taking your card's APR (Annual Percentage Rate) and dividing this number by 365.
For example, assume you have a statement balance of $1,000 and make a payment of $800 on the due date. You'll be charged interest on the remaining balance of $200 and lose your grace period. In the new billing cycle, any transactions will begin accruing interest immediately. The grace period where no interest is charged only applies if you pay your balance in full by the payment date.
Rule #4: Monitor your monthly statement
Monitoring your statement helps you check for fraud, stay on a budget and maintain a low balance. Even if you've set up an automatic payment, it's still wise to log in and check your statement every month to ensure there are no suspicious transactions.
Thankfully, most issuers have sophisticated technology that checks for fraudulent charges, but they may not catch them all. At least once a month, you should check your statement and verify there aren't any purchases you don't recognize.
In addition to checking for fraudulent activity, monitoring your statement will help you stay on budget. There's no way to know if you're maintaining a low balance, keeping your spending in check, or blowing the budget unless you're regularly checking in.
How to use a credit card to build credit
As the name suggests, credit cards are one of the foremost tools for building a credit score and can make a great foundation for your credit history. The best way to build your score using credit cards is to follow the recommendations listed above: Pay on time and in full, and keep a low balance. Below, you’ll learn how credit scores are calculated and exactly how credit cards affect them.
Know how your credit score is calculated
The FICO Score is the most commonly used credit score that most lenders refer to and is made up of five key components:
- Payment history is determined by how often you pay on time and how reliable you are as a borrower.
- Credit utilization is the ratio between how much you borrow (balance) to how much is available to you (credit limit).
- Length of credit history is how long you've used credit — the longer, the better.
- New credit is how often you apply for credit products or loans, and what percentage of your credit comes from recently opened accounts.
- Credit mix is how many different types of credit you use.
FICO Scores range from 300 to 850, and the average score is 701. It takes time and patience to build your credit score. Since the length of credit history determines 15% of your score, it's a good idea to start early and learn how to manage your credit properly.
Other strategies to help you build your credit score
Payment history and credit utilization make up 65% of your score. Because these two factors alone comprise the majority of your score calculation, you should maintain a low balance and never miss a payment to beef up your score. If you're already following these principles, here are four more strategies to help you build your credit score:
- Never cancel your first credit card. Unless it has an annual fee, you want to keep your oldest line of credit as long as possible, as this will help your average account age.
- Ask for a credit-limit increase, but don't increase your spending. Call your credit card company for a credit-limit increase if you want to reduce your credit utilization ratio. This tactic will help your utilization score by decreasing your ratio.
- Open a new credit card and then set a recurring bill and automatic payment to that card. Setting up this small recurring payment (such as a streaming subscription) will help both your overall utilization and your payment history.
- Pay off all your credit cards a few days before each statement closes if you're applying for a loan soon. Paying off your cards early will decrease your overall utilization and boost your credit score for a few days.
How to use a credit card to earn cash back and rewards
Earning rewards from a credit card is the fun part. But first, you should consider what your top spending categories are, then pick a card that will provide the best returns for you. Everyone's spending habits are different — some people may spend a lot on travel, while others only spend on groceries or takeout.
Analyze your spending habits to maximize your rewards
Take a look at the past few months of your spending and categorize it as best you can. Ask yourself the following questions: Do you spend a lot on gas and groceries? How often do you travel? Can you put work-related purchases on a credit card and then get reimbursed by your company?
Once you figure out which categories you're spending the most in, start researching different credit card options that fit your needs. After analyzing your spending, you may find that you want to use two credit cards to maximize rewards. However, while juggling cards can help you earn more rewards, don't get so distracted you end up spending more than you usually would.
Understand cash back vs. points vs. miles
Next, you should consider which types of rewards you're looking for. There are three main types of rewards currency: cash back, points and miles. It may make sense to earn points and miles through travel rewards cards if you like to travel. If you prefer to earn cash rewards, look at cashback cards instead.
Credit card rewards can be confusing, and most credit cards have restrictions on how you can redeem the rewards. For example, some cards require a minimum redemption threshold, or you may have to wait multiple billing cycles to receive your rewards. Consider how much time and effort you want to put in versus getting a simple card with straightforward options.
Below, we've hand-picked our favorite beginner rewards credit cards that are easy to use and offer excellent returns:
|Travel rewards||$95||5x on travel purchased through Chase Ultimate Rewards®, 3x on dining and 2x on all other travel purchases|
|Citi® Double Cash Card – 18 month BT offer||Cashback||$0||Earn 2% on every purchase with unlimited 1% cash back when you buy, plus an additional 1% as you pay for those purchases.|
|Chase Freedom Flex℠ Card||Rotating categories||$0||5% cash back on up to $1,500 in combined purchases in bonus categories each quarter you activate. Enjoy new 5% categories each quarter! Plus, earn 5% cash back on travel purchased through Chase Ultimate Rewards®, 3% on dining and drugstores, and 1% on all other purchases.|
A credit card can make or break your financial future. If used correctly, you'll enjoy a plethora of benefits, from a great credit score to valuable credit card rewards. However, if you fail to manage your credit card responsibly, you may find yourself spiraling out of control and into debt. Knowing the basic principles of using a credit card can avoid the latter outcome entirely and secure a promising outlook for your personal finances.