The word “credit” can generate a lot of emotions. Some people carry a negative connotation with the term, or think credit means debt and irresponsibility; but credit, when used with providence, can be a very good thing. Though buying a car and home may not be in your immediate plans, your financial choices today affect your long term goals.
Deciding when to start building credit is a personal decision. Credit cards are typically the most common product offered to start building credit history. If you’ve recently made an online purchase, booked a flight, gone to a financial institution or department store, you’ve probably been offered a credit card. Before applying for your first or next card, be sure to know what you’re signing up for.
What is a Credit Card?
A credit card is a card issued from a lender with a set limit available for use. Credit cards can be used to make any purchase. Unlike debit cards that draw funds directly from your accounts, credit cards use borrowed funds to complete transactions. The money used on the card is considered a revolving loan. Revolving means you can use it, pay for what you used, and use it again. You can pay the card back all at once or by making monthly payments. Interest charges are added monthly if the balance due is not paid in full.
The set amount available for use, determined by the lender, is your credit card limit; the proportion you pay, of the borrowed funds used, is the interest rate. Limits and rates vary depending on a variety of factors. Your credit history and even the credit card type can influence your limit qualification and the interest rate at which the cards are offered.
Credit Card Types
Since the usage will directly impact your credit score, choose a card that’s manageable and suits your spending habits. Major credit cards (e.g. Visa, MasterCard, Discover, American Express), often available through banks and credit unions, typically offer lower interest rates and higher limits than store cards (e.g. Target, GAP, Lowe’s credit cards). Many credit cards carry incentives for their use, such as airline miles or points redeemable for cash.
The amount you borrow and don’t pay back reports to credit bureaus monthly. If you plan on keeping a balance on your credit card, be sure to keep the balance due below 30 percent of your limit to optimize your credit score.
Credit Card Pitfalls
Be cautious with your selection and usage of credit cards. Certain lenders have an annual maintenance fee to keep the card open, or offer a low introductory rate only to increase it after the first year. When credit cards are not paid back in full, interest fees are added to the balance. Minimum payments typically go to cover the interest charges rather than the original amount you used. These fees add up, and over time can make it seem as though no progress is being made to pay down the borrowed amount.
Additionally, while credit cards are a great way to start building credit, it’s better not to use one than to use it irresponsibly. Late payments, maintaining a high balance, and maxing out credit cards can all affect your score negatively. It only takes a little while to bring down a credit score, but can take years to repair one.
Credit cards can be helpful for emergencies or simply to show positive repayment history. They can also be overwhelming—and even confusing, so apply for one when you’re ready to take on the responsibility. Your financial independence and well-being is in your hands.