Are you using credit cards to your advantage or getting played?
Hi guys! Today I want to discuss credit cards. I want to explain how exactly they work, how they affect your credit score, and pitfalls to avoid with them. This topic may seem really basic to people, but almost everyone has at least one credit card, and most people don’t fully understand their credit card terms. Everyone who has a credit card should know the following:
What your APR is on purchases
APR on balance transfers or cash advances
Minimum payment
Credit limit ( this will fluctuate depending on the person and not the specific credit card)
Credit card annual fees
Promotional offers
Rewards
If your palms are getting sweaty and you’re already freaking out, don’t worry I’m going to break this all down for you.
If I’m being completely honest, if you pay your credit card in full every month, you likely will not have to worry about half of these topics. But if you don't, these become much more important.
APR
So let’s start with your credit card’s APR. APR stands for annual percentage rate. This is fancy speak for what you’ll be charged in interest to carry a balance on your card. In other words, what percent you will owe if you don't pay the full amount each month. APR can change on credit cards, and if you neglect to pay for 60 days can even fluctuate to a much higher rate. This just to say read the fine print that no one ever reads. If you already have a credit card, check your monthly statement and it will say at the bottom what the APR is. If you check your credit cards online you can view the statement, and interest (APR) there.
MINIMUM PAYMENT -AKA WHAT YOU SHOULD PAY IF YOU ENJOY BEING POOR
Now, I hope this next part doesn’t pertain to most of you because I'm hoping most people are able to pay off their card in full each month. But I want to discuss a minimum payment. What is the minimum payment? I was speaking to someone who thought if they made the minimum payment each month interest would not accrue on the remaining balance on their credit card. And this is most definitely not the case.
A minimum payment is the amount you have to pay each month so that all hell doesn’t break loose. If you don't pay the minimum fee monthly you can be hit with a late fee, and a penalty APR. In other words, they can increase your interest. In addition, your credit score can be dinged and your account can be considered delinquent. 35 % of your credit score is determined by how often you pay your bills on time. Specifically at least the minimum payment. How do they figure out the minimum payment? Well every card is different. If you owe a large amount, say over $1,000 your minimum balance will often be around 2 %. If you owe less , say $200, sometimes you will have a flat fee like $25. If you owe a very small amount the minimum might be the full balance. But again this is just the fee that is REQUIRED. The rest of your balance is still accruing interest. Interest that’s determined by your APR.
By law, the credit card companies have to make available to you a “minimum payment warning”. This will actually show you how long it would take to pay off your debt, that is your current debt, if you only paid off the minimum amount each month. And it’s super depressing. But it is also very informative, and great motivation to not hold a credit card balance.
I want to take a second to go over an example to illustrate just how much you’re screwing yourself over by only making minimum payments.
Say you had a credit card with a $5,000 balance and your minimum payments were 2% of the balance or $100 a month. Assuming an APR (interest rate) of 18 % it would take you 93 months or almost 8 years, and you would have paid a total of $9,311. Paying just an extra $100 a month with all the same terms would have your debt paid off in 32 months or a little over two and a half years and you would have only paid $6, 314 . This is if you don’t put any more money on your credit card. This is all to show that minimum payments suck and putting anything you can towards the monthly payment really does make a difference, even if you feel like it's a ridiculously small amount. If you want to get serious about credit card payments you can google a credit card payoff calculator and figure out for yourself how long it will take to pay off your debt. You might be surprised how quickly little changes can add up.
CREDIT CARD FEES
On top of the interest you pay on a credit card you also pay fees. And they will really stick it to ya. If you don’t make the minimum payment on a credit card on time- there’s often a fee, and as mentioned earlier possible APR increase and reduction in credit score. If you go over your credit card limit, there’s a fee. If you do a balance transfer there’s often a fee. If you’re unsure what a balance transfer is, it’s basically when you put money you owe on one credit card onto another. People often do this when there are special introductory bonuses on a different credit card. I would just urge you to be careful because those introductory bonuses often come with terms. If you are late on a payment , this can negate the introductory offer. Again it’s in the fine print. Introductory offers include things like 0 % APR for 12 months, or a sign up bonus of money or rewards. They’re not always bad offers, but again read the fine print. Using.a balance transfer isn't inherently bad if you have no other options, but the goal is to not have any balance on credit cards in the first place. And I would think in most cases, unless your spending drastically changes at the end of the introductory offer you would risk being right back to where you started. If you had a solid plan to pay off this credit card while benefiting from the interest free period then it could work.
Just something I want to mention about fees. Most of the time in life you can get all types of fees waived just by asking. I remember going to get my first car. I brought my father, and just as we were signing the paperwork, there was a $300 fee for some bullshit like “ we had to do our due diligence with a credit check and now we're charging you.” I was thinking well shit, I guess I have to pay an extra $300. Then my Dad said no we’re not gonna pay that. And the salesperson asked his reason and my dad eloquently said “ We don’t want to and we’re not going to “. And I thought, this can’t possibly work right? But it did work. Most people don’t even look at the fees, they just sign on the dotted line. And this taught me a valuable life lesson, don’t accept useless fees, and look at what you’re getting charged. The same goes for your credit card. If you get charged a fee you can call them up and ask them to waive it for you. If they ask why , you can come up with some bullshit like “I’m a good customer and I usually pay on time”. It might not work 100 % of the time, but I will say every time I have called my credit card company over a fee, I have always been reimbursed. Other things you can call your credit company about are lowering your APR, or extending your credit card limit.
CREDIT CARD LIMIT
When you get a credit card you will be assigned a credit card limit. This is the amount of money you are allowed to charge to the credit card. If you try to go over the limit you can get your transaction declined, be subjected to a fee, and even get dinged on your credit score. Interestingly, part of your credit score is determined by what proportion of your credit limit is being used. So for example, it’s easier to improve your credit score if you keep $4500 out of a $30,000 credit card limit then it would be to improve your credit score if you often kept $4500 out of a $5,000 limit on a credit card. So if you want to lower the proportion of the credit card being used you can request to have your credit limit increased. You just call your credit card company or request an increase online . I just want to add as a PSA DO NOTt request to have your credit card limit increased if you know you can not responsibly handle this.
CASH ADVANCE
Next I want to discuss a topic I was asked about. A cash advance. A cash advance is basically when you use your credit card to get money. It’s like you bought cash instead of stuff. You still have to pay it back. and it’s a really useful tool- if your goal is to stay broke. Cash advances are virtually never a good idea. Like I would get on Facebook marketplace and start selling some shit before I would do a cash advance. And the reason is because the overall cost is insane. First, there is usually a fee associated with a cash advance from your credit card company. Sometimes it’s a flat fee like $10. Other times, it’s a percentage of the amount of the cash advance. Next, the bank or ATM you get your actual cash from can charge you a fee. And lastly they charge you interest that starts accruing immediately on the cash. With most purchases on your credit card you don’t have to pay until you credit card payment is due, but with a cash advance the interest starts immediately. And if they haven’t found enough ways to screw you over, the interest rate is often higher than what you would normally be paying. If you’re still confused about how I feel about cash advances, I think they’re a predatory practice and almost never a good idea. If you do have to take one, pay it back as soon as possible, because the clock is ticking my friends.
CREDIT CARD FRAUD
One of the nice things about credit cards is you are pretty much always protected from credit card fraud. The Fair Credit Billing Act limits your maximum liability to $50. Most of the major credit card companies have zero fraud liability, which means they will not charge you anything for unauthorized transactions on your credit card. If this ever happens to you, you should report the charges the second you are aware of them.
HAPPIER THOUGHTS…
So far, there’s been a lot of gloom and doom conversations, but just to be clear I am not a credit card hater. I just want everyone to know what they’re actually paying. I don’t believe credit cards are inherently bad. I don’t prescribe to the Dave Ramsey method of never using a credit card. If you use a credit card correctly, you can really spin it to your advantage. If you pay off your credit card in full each month, you can and should use credit cards to get rewards. But it’s really important to not hold a balance on your credit card. If you have a rewards card and you get excited about 3 % rewards , but you’re still paying 18 % APR you are getting screwed. If you’re paying interest, you’re the one funding these perks for the people that pay their credit card on time.
As you’re probably aware, there are different types of incentives on credit cards. There are credit cards that give you cash back and travel cards that give you rewards that can be used for travel. Generally speaking, if you’re using a travel card, use it to book anything related to travel, like cars, hotels, fights, and when you dine out. Use your cash back card for the rest of your purchases.
My favorite travel card is the Chase Sapphire Reserve, or Chase Sapphire Preferred.
There are entire blogs devoted to travel hacking where people use their credit cards to get free travel. They essentially open several cards to take advantage of the introductory offers, and then use these rewards for travel. I think if you're ok with a little research and tracking this, it’s probably a good strategy. For me, that seems like a shit load of work, so for simplicity sake I just have a travel card , and a cash back card.
NERD ALERT!!
And just an interesting aside about credit cards because, in case you couldn’t already tell, I'm a nerd. If you’re wondering how credit card companies as a business work, credit cards make money 3 ways; interest, fees, and interchange. Most everyone is aware of interest and fees because they’re the one paying them. The third way credit card companies make money is a lesser known method of profit called the interchange. I didn’t understand this until I became a business owner. Basically if you’re a business you have to pay an agreed upon fee to let your customers use a credit card at your business. And I use the term agreed upon loosely because the credit card company offers me no choice. This interchange rate is usually between 1-2 %. This rate doesn’t directly correlate to the rewards you are receiving. Some cash back cards offer 3% or even 5 % back, and the interchange rates aren’t going to cover that full amount. Credit cards are able to continue to cover the difference due to all the other fees, and interest they charge you. Oh and the business you’re frequenting pays an interchange fee and also has to pay a separate company to process this interchange fee.
I hope all of this has been helpful.
So just to wrap this up, if you’re looking for a credit card and pay your bills on time, you’re probably going to be more concerned with the rewards or cash back incentives. If you’re looking for a credit card and don’t always pay your bill in full each month, you should know the in’s and outs of your credit card. At the very least you need to know your APR. You could even call your company and see if you could get it reduced. If you absolutely can’t pay it off in full, put any amount you can towards it. You’ll be getting some of the best return on your money you can find.
So if you haven’t figured it out by now, I’m actually a huge credit card enthusiast. If you’re paying the card off entirely every month, you can really use the rewards and travel perks to your advantage. If you’re not paying the card off in full, it might be wise to consider switching to a debit card.
I hope you all enjoyed this little quick and dirty lesson on credit cards. Have a great week guys!
