If you’re anything like most adults, you’re probably getting bombarded with direct mail offers asking you to sign up for the latest and greatest credit cards. It can get overwhelming fast. You’re probably wondering which cards you should sign up for, how many you need, and what APR means. Let’s start with the basics.
Do You Really Need A Credit Card?
Before you decide whether or not you need a credit card, you’ll need to ask yourself what you would be using the credit card for. Credit cards are great for building credit, getting rewards, and spending money without having to move cash around. Credit cards do not give you free money – don’t forget that you’ll need to pay it all back at the end of the billing cycle.
How do Credit Cards Work?
Having a credit card is a big responsibility that you should not take lightly. Whatever money you spend or borrow, you are responsible to pay back at the end of that month or 30-day period, which is known as a “billing cycle.” The billing cycle may or may not line up with the calendar month, so make sure you know when your billing cycle starts and ends. If you don’t pay off your entire bill by the end of the month, the interest can add up quickly.
Paying Your Minimum Payment
A common misconception that new credit card owners believe is that you only have to pay your minimum balance each month. Paying the minimum balance is indeed required to avoid extra fees, but if you only pay the minimum and still have expenses remaining, you will end up owing interest on those remaining funds. The more you can pay off every month, the better.
APY vs. APR
APR refers to the annual percentage rate of interest you will pay on your loan or credit card balance. APY refers to the annual percentage yield you will pay on your loan or credit card balance. The key difference is that APY takes into account compounding interest, while APR is based on simple interest.
Compound interest is the interest that you earn on your interest. Confused yet? Here is an example:
If you have $100 on your credit card bill and your APY is 5%, you’ll owe back $105. If you were to not pay that back until a year later, you would owe an additional 25 cents (5% of the extra $5 in interest). Now, this example is tiny, but it can all add up very quickly.
To calculate your APR, divide your APR as a decimal by the number of days in the year. Then, multiply it by your average daily balance, then multiply that number by the number of days in your billing cycle.
For example, let’s say your APR is 15%.
.15/365 = .00041096
.00041096 x $500 = $.21
.21 x 30 = $6.30
In this example, where your credit card balance at the end of the month is $500, you would owe $6.30 in interest. Now, let’s say you had an APY of 15%, compounding monthly (interest on your interest, a.k.a compound interest). After a year, you would owe an additional $80.38 on top of the $500 that you used.
How Soon Do You Have to Pay Off Credit?
It’s always best to pay off your credit as soon as possible to keep your credit score looking good. If you’re already deep in debt and struggling, set a goal for yourself to pay off a certain dollar amount every month, and you’ll get there a lot faster. Be sure to pay off your minimum balance every month to avoid extra fees and prevent your credit card company from sending you to collections.
How to Choose Your First Credit Card
When deciding on what your first credit card should be, you will likely have a lot of options. The first thing you’ll want to compare is interest rates (APY and APR). Then, consider what rewards or benefits each card offers. However, don’t let those rewards distract you – the extra perks (like cashback, airline miles, store credits, etc.) are nice, but the APY and APR are more important for your overall financial wellness.
Store Cards & Good Rewards Credit Cards
Even if you’re just starting on your credit journey, there are still options available that could get you some pretty good credit card rewards and cashback opportunities. A few examples of common credit card rewards are cashback on your purchases and discounts on travel and streaming services.
You can also start by signing up for a store card. However, be careful to not sign up for every card that your cashiers recommend. Too many cards can hurt your credit (and it can be hard to remember to pay all those bills). It’s best to start with a card from the store where you shop the most often, since you’ll be best able to reap the rewards that way. Stores like Amazon, Walmart, Target, Gap, and Lowes all have credit cards. You can use these cards anywhere, not just at the store that gave it to you, and it can help you build credit if you pay it off on time. They usually provide discounts on goods sold at the store that owns the card.
Credit Cards with No Annual Fee
Some popular credit cards charge an annual membership fee (like American Express at $95/year). If the credit card you’re interested in has a comparably low APR/APY but charges a fee, it might be worth it to pay the fee. However, if you’re someone who stays on top of your bills and you are confident that you will always be able to pay your credit card bill in full, it may make more sense to select a card with a higher APR/APY but no annual membership fee.
Five Biggest Lies About Credit Cards
Unfortunately, not all of the information out there is accurate. When researching credit cards, make sure you are looking at reliable sources such as Experian and Equifax. Here are some of the common myths that may be holding you back.
Credit Cards are the Way to Build Credit (LIE)
One of the most common myths that many believe is that a credit card is required to have a credit score. Credit cards can impact your score, but there are several other factors that impact it as well. Outside of credit cards, you can build credit by paying down loans and even reporting rent to credit agencies. While having a credit card can certainly help, it is not the only way to build your credit history.
Keeping a Credit Card Balance is Healthy (LIE)
New credit card users tend to fall for this credit card myth. There’s no real benefit to maintaining a balance on your credit cards for months at a time. The best thing you can do to help build your credit is to pay your balances in full before the end of your billing cycle.
You Have to Make A Lot of Money to Have A Credit Card (LIE)
Credit cards are available for people with all types of income levels. The key is to find the card that suits your needs, doesn’t charge you any fees, and is going to help you establish and maintain a healthy financial outlook.
Credit Cards Are Necessary for Emergencies (LIE)
You shouldn’t view your credit card as a source of emergency funds. While they technically can be useful in emergencies (since you don’t have to have the cash in your account on the date of the emergency), it can be dangerous to treat credit cards in this way. The added interest will come back to bite you.
Having an emergency fund or separate savings account that you contribute to every month is a much better way to stay prepared in case of emergency. While a credit card can be helpful in an absolute pinch, it should never replace an emergency fund. In fact, Rain can be very beneficial in emergencies, since you would be using the Rain Instant Pay app to access funds that you’ve already earned (but haven’t received yet).
The More Credit Cards, The Better (LIE)
While it is true that having more than one credit card can boost your credit history and therefore increase your credit score (as long as you’re paying it off each month), there is no need to apply for every card under the sun. In fact, applying for too many cards can hurt your credit score and be a reason why you are denied for a new card.
Credit companies typically do not like to accept applicants who appear to be opening accounts with reckless abandon, as it shows that you may be at risk for credit abuse. So, while it is tempting to apply for every card that you qualify for at first, focus on building your score with one card company, like Visa, and then consider a different type of card company for a second, such as Discover.
Three Most Important Truths About Credit Cards
Above all, these three truths are the main reasons why it may be time for you to open a credit card.
Credit Cards Are Healthier Than Short-Term Loans (TRUE)
Short-term loans might appear more attractive in some situations as they can provide a lump sum payment that can be spent anywhere, but it’s better for your financial health to stay away from them.
A credit card will provide you with revolving access to funds when you need it, whereas a short-term loan is a one-time payment. If you find yourself needing money again, you’ll have to apply for another loan, which isn’t a situation you want to be in. Credit rating companies also value your ability to spend responsibly with your credit card over how well you repay a short-term loan. You also have more flexibility with a credit card in regards to repayment, as you can make a minimum payment if you are ever strapped for cash. A short-term loan will require the same fixed payment each month.
Just remember: credit cards are not for reckless spending. They are easier to pay back than short-term loans, but they’re still not free.
Credit Cards Can Help You Build Credit (TRUE)
While credit cards are not necessary to build credit, they can certainly help. When you can proudly say you can spend and repay responsibly, credit card companies will take notice and your credit score will improve over time. Several factors go into determining your credit score, but having a strong credit card history is a large part of this.
Credit Cards Are Easy to Get (TRUE)
The truth is that credit card companies want your business. You might not be eligible for every credit card imaginable, but there is more than likely something out there for you. If you aren’t happy with the offers you have been receiving or with those that you have qualified for, there are ways that you can improve your credit score first.
With so much information out there about credit cards, it can be difficult to know what the best option for your situation may be. Regardless of your income, credit score, or job history, there are options available to help you develop a stronger credit score and create healthier financial habits.
About the Author
Ben Smith is a writer and educator from New York State. Ben has written for various finance companies and publications for over a year and enjoys helping others understand and improve their personal financial situations. When he is not writing or teaching, he enjoys spending time with his wife, Laura, and their Anatolian Shepherd, Theo.