Making the decision to apply for a credit card is a pretty big deal. We've seen our parents struggle with credit card debt, heard horror stories of interest charges crushing family budgets, lost trust in banks as they mishandle assets and cause financial meltdowns, and we are still struggling with soul crushing student loan debt. Shying away from credit cards is a natural instinct and some would say a smart move. We'd encourage you to not make this same mistake.
Why Credit Cards are Important:
Credit cards are a healthy addition to your credit portfolio, signaling to banks that you are a trustworthy borrower. Adding a credit card to your wallet will help you build a credit score that will give you access to lower interest rates when you look to buy a car, a home, or refinance existing student loans. How is your credit score calculated?
1) 35% of your score is based on payment history. Having a loan where you consistently make on time payments is crucial to having a good credit score. If you are leery of credit cards, it's not a bad idea to find a card with no annual fee, and make a small dollar charge each month. This keeps your account active and helps you build a payment history. Just make sure you pay that bill in full each month to ensure you aren't taking on finance charges.
2) 30% of your score is based on the amounts you owe. This is another reason why paying your balance each month is important. Your credit usage should remain below 30% of your available credit to keep your score in good shape. That means if you have a $2,000 credit line, you should aim to carry a balance of less than $600, if you must carry one at all. If you are in a situation where you need to carry a balance, look for cards with 0% APR intro periods. These will often let you carry balances for 12-24 months without incurring interest fees.
3) 15% of your score is based on length of credit history. How long have your accounts been open? This is one reason to open a credit card now. The longer your history, the more positive the impact on your score. You can fix things like payment history and account usage. You can never go back in time to open a card though.
4) 10% of your score is based on your mix of accounts. Banks like to see that you have multiple product types, i.e. a mortgage, auto loan, and a credit card. This helps show you are a responsible borrower.
5) The last 10% is based on the number of recent credit inquiries or new credit lines opened. Trying to open multiple lines around the same time will make you look desperate, and as a result more risky. If you've held off on getting a credit card until now, this shouldn't be an issue for you.
Know Your Score:
If you don't know your score, use a free tool to get it. We'd recommend Capital One's CreditWise. Knowing your credit score will help you apply for a credit card that you are likely to qualify for.
What Kind of Credit Card is Right for You:
Card come in many types. As a consumer, you have a lot of options to meet your budget and lifestyle.
1) Rewards Cards - Rewards cards are going to tend to have higher interest rates to help the banks pay for the cost of awarding rewards, but if you are paying off your balance in full each month it shouldn't matter. Rewards cards are great for people that love to travel. They often come with perks like lounge access, the ability to earn reward flights or hotel nights, and even travel credits. These cards can carry annual fees, so you'll need to balance whether or not you'll get value out of those. Getting a reward night at a hotel every year or a bonus flight just for paying your bills can be a nice perk. Be sure to have excellent credit if you're applying for a card with an annual fee.
2) Cash Back Cards - Similar to rewards cards, cash back will give you a % back on each purchase. Some will offer a flat rate on every purchase, others will have categories like gas or grocery that earn at a higher rate, and others will have increased bonus categories that change throughout the year. When picking a cash back card, you should be somewhat aware of what you are spending money on each month, so you can pick the card that nets you the most cash back. Like rewards cards, cash back cards will have a slightly elevated interest rate, and may carry an annual fee. You'll need good - excellent credit to snag one of these.
3) Intro Interest Rate Cards - These cards will allow you to make charges for 12 - 24 months without incurring a monthly interest fee, as long as you make your minimum monthly payment. These can come in handy if you need to make a large purchase, like a new appliance. If you have an existing balance on another card, you can also transfer that over to get a 0% intro rate on your balance, which can be quite the money saver. Just be mindful of any balance transfer fees your new card may charge. Many low interest cards can be obtained by users with average to good credit.
4) Charge Cards - Charge cards are a bit of a dying breed. You'll want excellent credit if you are applying to a charge card. There's no real perk to these. You have to pay off your balance each month, so you won't receive an interest charge, but we don't like not having the flexibility to carry a balance in the event of an emergency. There are often lofty fees associated with charge cards, so we'd generally recommend staying away.
5) Secured Cards - Secured credit cards are a good option for those with bad credit, that need to do some repair to a damaged credit report. Secured cards will often carry very high interest rates, so definitely plan on closing out your balance each month. With a secured card, you'll put down a deposit equal to your credit line, and the back will hold that as an assurance that you'll pay your bill. You'll typically be looking at a minimum or $200 - $300 deposit. After a period of on time payments, most banks will review your account and convert you to a standard credit card and return your security deposit. If not, you can use the credit history you've built to try to move to another bank after 12 months or so.
6) Prepaid Cards - Prepaid debit cards won't help you build credit, but they might help you budget better. If you are currently operating in an all cash economy, a prepaid card is a good way to test the waters if you don't trust yourself managing a budget. Once you're comfortable managing your day-to-day, make the jump to a no annual fee credit card.
Our Two Cents:
Credit cards are a good tool to have in your financial arsenal. Don't repeat the sins of those that came before us and open the door to a cycle of debt and borrowing, but use credit cards as a way to improve your financial standing. You may hate the game, but you can still be a smart player.