How to Money, Episode Two: Credit Cards
If you spent last week living under a rock that was buried under another, much larger rock, then you might have missed our big announcement: We’ve launched a new video series called “How to Money”!
Every episode we talk about a different financial topic. Some of these will be everyday terms, while others will be a little less common.
If you haven’t watched episode one, you can check it out here. It covers the basics of Annual Percentage Rates, also known as APR. Check back for new episodes every Monday.
What are credit cards?
Okay. So we’re pretty sure you know what a credit card is. These days, they’re pretty much inescapable.
But they can also be pretty dangerous. According to a recent study, the average American household has over $16,000 dollars in credit card debt. Plus, credit cards come with an average annual percentage rate of 16.5%, which basically means that that the average household is paying over $2,500 in credit card interest alone every year.
How do credit cards work?
Credit cards operate as a revolving line of credit, which means that they’re a little bit different than a regular personal loan. With a regular loan, a lender gives you a set amount of money. You then pay that money back to the lender over a set period of time through a series of regularly scheduled payments.
With a credit card (or a revolving line of credit) the lender doesn’t give you a set amount of money. Instead, they give you a set amount that you can borrow up to. This is referred to as the card’s “credit limit.”
You can then borrow as much or as little money as you like–so long as what you borrow doesn’t exceed the credit limit. Your credit card balance is a “revolving” balance, which means that amount you have to spend against your credit limit replenishes as you pay your balance down.
With a credit card, you’ll still get charged interest–because that’s how the lender is making money on your loan. However, with a credit card, you’ll only get charged interest on the amount of money that you actually borrow, not on your total credit limit.
Once you’ve spent money on a credit card, you’ll have to make a minimum payment every month. It’s usually something like two to four percent of your total balance plus whatever interest has accrued.
These monthly minimum payments are pretty small, which means it could take you several years at least to pay the card off making only the minimum payment. And that’s by design. The longer it takes you to pay off your card, the more interest you get charged, and the more money the credit card company makes.
How to use credit cards properly.
One of the great things about credit cards is that a lot of them come with points and rewards. By spending money your card, you can rack up those points and use them for air travel, discounts, gift cards, etc.
But in order to use a credit card properly, you should be paying off your full balance every single month. Do you spend $500 on that card? You pay that $500 off immediately. That way, you get the rewards without accruing interest.
Wait. Why wouldn’t you accrue interest, again?
Well, that’s because credit cards come with a one-month grace period–which means that a purchase made on the card doesn’t start accruing interest until one month after that purchase is made. So paying your balance off in full every month basically means you get the rewards for free
Remember, a credit card isn’t an excuse to spend beyond your means. While they can be handy in the case of absolute emergencies, you should otherwise only be using your card to spend money that you already have.