Wednesday, April 15, 2015

How To Use A Credit Card - Part 1
In today's world, your credit score impacts many aspects of your life, some not even related to finance. In addition to determining what interest rate you'll pay on loans, your credit score can be used to determine your insurance rates and your ability to get a new job or a new cell phone. Many people who advocate living debt free also advocate not having any credit cards at all. Because your credit score is used in so many different ways, and because credit card use makes up a large portion of your credit score, not having credit cards may actually hurt you in the long run. If you cannot show lenders or service providers that you can responsibly manage debt, they will either not lend you money at all or charge you a higher interest rate than you should be paying.

Credit cards are not something to be afraid of or avoided. They are simply a tool. They can be used for good or evil. They can bring you rewards and perks, but they can also drive you to bankruptcy.

The Basics

The Cardinal Rule

The Number One rule when using credit cards is: Don't carry a balance. Pay off the card in full, every month. If you do this, you are getting an interest-free loan from your credit card company, which is a good thing. It means your money sits in the bank earning interest while you spend someone else's money throughout the month. Of course, there's no such thing as a free lunch, so you will have to pay the credit card company back, but if you do this in full each month, they won't charge you interest. If you don't however, they will - usually at an incredibly high interest rate in the 15% to 25% range. Paying interest raises the cost of whatever it was you purchased. You know those killer shoes you found on sale for 50% off? If you charge them and only pay the minimum due amount on your credit card statement, they weren't 50% off. They were probably more like 50% extra.

Always Use Protection

Credit cards give you a certain amount of protection. If you purchase a product or a service from a company and you have problems with it that you can't resolve with the seller, you can many times call the credit card company and file a complaint or a charge back. The credit card company will either remove the charge from your account entirely or place the charge on hold while they contact the seller to resolve the situation on your behalf. While they are doing this, you do not have to pay the charge and they will not charge you interest on the amount in question until the issue is resolved.

You are also protected in case the card or (more likely these days),  the card number, is stolen. Laws governing credit card companies say you are responsible for only up to $50 of fraudulent charges (providing you notify the company within 60 days). If you have the card stolen, you might not be responsible for any amount if you report the loss immediately.

Annual Fee

Look for a card that does not charge an annual fee. Cards that offer rewards usually charge an annual fee (I'll talk about those next week), but there are plenty of cards out there that don't. Get one of those. They may have a slightly higher interest rate than a card with an annual fee, but since you're never going to carry a balance anyway, the interest rate doesn't matter, right?

Debit Versus Credit

Debit cards look and work just like credit cards and some debit cards can also be used as a credit card. However, there are important differences between the two. With a credit card, you are spending someone else's money and, when the bill comes, you pay them back. When using a debit card, it's your money you are spending and the money comes out of your account almost immediately. This can cause some serious issues if your card is stolen or used fraudulently. Yes, the bank will eventually return your money to you, but you'll have to do without that money until the case is settled, which could take weeks.

You also have fewer protections when using a debt card. You remember that $50 liability limit I mentioned before? Doesn't apply to a debit card. Many credit cards also offer perks, such as free flight insurance when buying airline tickets, free auto insurance coverage when renting a car, automatic extended warranties on some items purchased, etc. Debit cards generally don't provide these benefits.

If you have a debit card that can also be used as a credit card, how do you know which it's being used as for a particular transaction? The most sure-fire way to tell is to remember this rule:

PIN = debit
Signature = credit

When you swipe your card at a payment terminal, choose the "Credit" option, not "Debit." You'll be asked to sign your name instead of entering a PIN. But beware! I have seen some terminals that ask you for a PIN even if you choose "Credit"! If you enter a PIN, you are using your card as a debit card, NOT a credit card, no matter what you selected. (Merchants prefer debit cards because they aren't charged as much to process them as credit cards, which is why you see these sneaky attempts to get you to enter a PIN.)

It's important to note that, even if you choose "Credit" and sign your name, if you are using a debit card, the money will still come out of your account almost immediately. You won't get a bill at the end of the month. You will gain the financial protections of a credit card, though - the $50 liability limit, etc.

How Many Cards Do You Need?

Not many. Too many credit cards can hurt your credit score, so you don't want to go crazy. Having 10 to 15 credit cards, even if there are no balances on them, will hurt your score. Thirty percent of your score is based, in part, on your available credit. Many cards = lots of available credit, which means you could go out and max out all those cards in one day and easily get into more debt than you can handle. I think a good limit is 3 or 4 cards. I own three - one Visa, one American Express, and one Discover. You may want to get a MasterCard as well, just so you have one from each issuer and therefore, will likely always have one that is accepted somewhere.

Those are the basics of credit card usage. If you pay attention to these, especially the part about always paying the balance in full each month, you'll never get into any financial problems and you'll be on your way to improving your credit score. Next week, I'll go over some of the more advanced features of credit cards and talk about how I use them.


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