Beginner’s Guide to Credit Cards (mainly for beginners and Europeans who don’t really understand the US credit system)
For many people, credit cards are confusing and can even be scary. Well, at least that’s what I think Dave Ramsey fans think. (Dave is an all money no credit preacher)
But, as someone who has a pretty good grasp of credit card fundamentals,
I’d like to share with you how they work, what you can do with credit cards, and how you can use them to build your credit history and score.
How Credit Cards Work
Every time you buy something with a credit card, you are using money from the bank to make that purchase.
You are then obliged to repay this money within a certain period of time to avoid being punished.
For most cards this is a 30 day period and then interest is applied to the debt due thereafter.
And, if you pay that money back within that time, you won’t pay any interest and you’ll actually be rewarded for your behavior.
In most cases, these rewards come with a small credit score boost or even some cash back rewards.
Credit score is a number that indicates how trustworthy you are with other people’s money. In this case, how trustworthy you are with the money in the bank. This number is a result of the type of debts you are currently paying and how often you pay those debts on time and in full.
What you can do with credit cards
The whole concept, as stated earlier, is about using other people’s money to buy things.
For most people, there are rules about best practices with credit cards. These best practices are set in stone by banks to better assess your reliability as a borrower:
- Use of credit card: Let’s say you have a spending limit of $1000. Banks like to see you using less than 30% of your credit limit. Thus, your theoretical maximum security does not exceed $300 per month/payment period.
- Automatic payments: For some reason, at least in the United States, your reliability as a borrower increases if you have larger debts that are paid on time and in full. IE: A recurring car payment has a bigger impact on your reliability than using your card for groceries.
And there is another “tier” of business credit cards. Although these types of credit cards are beyond the scope of this article, there are a few notable points to mention about these cards:
- They have significantly higher borrowing limits: There are a multitude of cases where having a 5-6 figure spending limit is useful for a business. It could be a homeowner receiving cash for a purchase or a business using a credit card to pay for an expense if they know there is a paycheck that will eventually cover the cost of this debt.
- SARL (limited liability company) credit is distinct from personal credit: At least in the United States, an LLC (for the majority) is considered its own thing, entirely separate from its creator. It creates a barrier between a person and an entity which, as the name suggests, limits liability (bad things that can happen) that could affect a person.
Personal best practices with credit cards
While there are things the banks want you to do, there are things I’ve done that you too can benefit from. The most important being:
Treat your credit card like a debit card: basically, don’t spend money you don’t have. If you have $500 in play money, your personal limit should be $500 spent on the card.
Advantages and disadvantages of credit cards
Although Dave Ramsey may claim otherwise, credit cards do more than hurt you.
The main advantages are:
- Build a credit score
- Earn a certain level of rewards (whether cash back or something else like member benefits)
- Are able to teach some level of spending discipline
- Can prevent theft (since the card is not directly connected to your bank account, any spending on a stolen card is spent at the bank’s expense)
- Keep you more on top of your finances (most cards come with an app to keep track of everything)
And the cons are:
- It can be tempting to overspend
- Your wallet is more inconvenient to carry because your cards make it thicker (1st world issues, I know)
How to Use Credit Cards to Build a Credit History
That in itself could be its own article. Hell, it’s quite a business model. But the only real things you need to know on a basic level are:
- Use a credit card to pay off large or long-term debts: As mentioned earlier, large, long-term debt has a bigger impact on your score than a grocery expense. Usually, you’ll use your own check or debit to pay for these kinds of expenses. But it wouldn’t hurt to just move them to a credit card. The only difference is that you now have a long-term credit history being built, and maybe even some benefits.
- If you are a parent, co-sign one for your child: This one looks risky, but you can place limitations and so on on the map to limit that risk. My parents did this to me, and as a result, I inherited my dad’s nearly perfect credit rating. It’s a great way to give your kids solid credit early on.
Although I have a different take on credit than Dave Ramsey, he offers some solid advice for people who really can’t control themselves. But for most people, just having any level of credit card knowledge will go a long way.
And, although I am not a financial adviser, simply real estate agent and pilot, I practice what I preach because I have seen this information work in real time.
So, at the very least, I wrote this article thinking that if the above information helped me, I think it can be useful to you as well.