The following is adapted from Your Money Vehicle.
You put in your application, got approved, and are now holding a brand-new credit card in your hands—your first credit card. Congratulations!
Before you start swiping that card, or perhaps before you even acquire a credit card, you must realize that this is a very different tool than a debit card. To understand the difference, there are five questions you should ask about your new credit account. Let’s take a look at what this information is and how it will protect you from making costly, avoidable mistakes, like getting a card with an astronomically high-interest rate.
Question #1: What Is a Grace Period?
A grace period is the amount of time you are given to pay off your balance in full before interest begins to accrue. This period starts on the first day of your billing cycle and ends on your payment’s due date. For example, if your balance is due on the twenty-third of the month, you will not be charged interest until the twenty-fourth.
Question #2: What Is the APR?
The Annual Percentage Rate (APR) is the interest rate the credit company will charge on a yearly basis. For example, if your APR is 17 percent, and you had a $100 balance for an entire year, you would be charged (17 percent times $100) seventeen dollars. That doesn’t mean you will be charged the full APR every day that you carry a balance, because the annual rate is broken down to a daily rate. Here is the formula to find out how much your daily rate is: annual rate divided by 365. For example, 17 percent APR = 17 percent/365 = 0.046 percent per day.
Question #3: What If I Am Paying the Minimum Amount Due?
If you’re only paying the minimum amount due on your credit bill every month, you’re falling right into what I call the credit trap. The credit card company wants you to believe that you are making the correct payment and tells you that you only need to repay 1-2 percent.
Ask yourself: who benefits from this payment amount? You or them?
Paying only the minimum amount due will cause you to continue to pay the credit company interest for years. Trying to pay off your credit by using the minimum amount due is like trying to bail out a sinking ship with a spoon. For example, if you buy $3,000 worth of furniture and are only paying the minimum amount due of $60 per month, you are carrying a balance. You will end up paying around $400 of interest in the first year alone, and you will still be charged interest on a balance of around $2,700!
Put simply, if you are paying off the minimum amount, you are going to lose a lot of money; paying large chunks is better, but you’re still losing money. There is no better investment than to get out of credit card debt as fast as you can!
Question #4: Is Visa or Mastercard My Credit Card Company?
Oddly enough, the answer is no. Those companies are the form of payment you are choosing to use. The credit card company will be a third party and Yes it can be your bank! They will also be listed on your card, such as Bank of America, Capital One, Chase, Wells Fargo. Be aware that most are traditional banks as well.
It’s important to know which companies you’re dealing with, so you know who to ask these questions to. Reach out and ask what their terms are so you aren’t caught by surprise when you get your credit card statement.
Question #5: What Do I Need to Avoid with My First Credit Card?
- For your first card, you should avoid any type of annual fee. You should not be using this card enough to warrant that type of fee. Also be on the lookout for gimmicks, as some cards waive the fee upon signing up, but will begin to charge it after a few months.
- Avoid at all costs a ‘cash advance’. A cash advance allows you to withdraw cash from your credit limit. When you do this, you accrue interest immediately, without a grace period like we discussed above, and the interest rate will be even higher than your APR!
- Never get charged off, which refers to missing payments for six months. This offense will negatively impact not only your cash flow, but also your credit score.
- Regardless of your credit limit, you should try to only use a maximum of 30 percent. Meaning that if you have a credit limit of $1,000, you should only use $300. This will positively impact your Credit Score which we will discuss in future topics.
Know Your Credit Card
The answers to these five questions will start you off with the basics you need to know about your new credit card. For your next step, learn the details of your specific account. When you understand the rules, limits, and fees that apply to your card, you can avoid making mistakes that will cost you, and you can instead enjoy the rewards of a credit card with fewer of the risks.
For more advice on financial planning, you can find Your Money Vehicle on Amazon.
Jedidiah Collins, CFP® is a behavioral coach and founder of Rookie to Veteran™. After being signed as an undrafted free agent in 2008, he played seven seasons in the NFL while studying for his certification in financial planning in the off-seasons. Today, Jedidiah’s mission is to empower students, athletes, and young professionals with the behaviors needed to eliminate the gap between the potential of their goals and the success they desire! In addition to his work, Jedidiah is a speaker, commentator, and—most importantly—a husband and father.