Looking to open your first credit card? Don’t know where to start? Don’t worry, we’ve got you covered.
We understand how overwhelming it can be to open your first credit card, which is why we’re here to walk you through the basics in this Credit Card Boot Camp. Let’s get started!
What is credit?
These days, credit cards are just a part of life. Whether you love them or hate them, credit cards have completely changed the way in which we, as consumers, go about our daily lives. From reducing our reliance on cash to creating a massive amount of consumer debt, credit cards have, for better or for worse, made their mark on the global economy.
But where does that leave you, the consumer? How can you possibly wade through the insane number of different credit cards to possibly find the one that best fits your needs.
Well, it all starts with the basics. First things first, let’s find out: What is credit, anyway?
If you’ve never used a credit card before, you might not fully understand what credit is. In fact, even if you frequently use credit cards, have four car loans, and student debt, you may not fully understand the concept of credit.
Let’s keep it simple: Basically, credit is just borrowed money. You can get credit from friends or family who let you borrow a few hundred bucks to get through a rough patch, or you can borrow money from a bank to buy a house (that’s called a mortgage) or to pay for college.
Types of Credit
That being said, there are many types of credit out there, so let’s discuss each in more detail:
If you’ve ever signed a contract with a service provider, like a credit card or utility company, you’re actually engaging in a form of credit known as service credit. In this form of credit, you enter into an agreement that you’ll pay all or part of the previous month’s balance for the services you’ve received, whether that be in household electricity or cell phone data. In fact, your monthly gym membership is considered a service credit as you’ve agreed to pay the gym each month for the privileges of membership.
Installment credit is a type of credit in which a creditor (usually a bank or financial institution) agrees to loan you a specific amount of money, often in the form of a loan. As the person who has taken out this money, you agree to pay back the funds within a specific period of time.
In exchange for the convenience of having this money, you also agree to pay back a specific amount of interest, in addition to your regular monthly payments. The most common types of installment loans include mortgages, car loans, and student loans.
A charge card is a type of payment card that looks and operates much like a credit card. Unlike a credit card, however, charge cards have balances that must be paid off, in full, every month.
When we talk about opening a credit card, we’re talking about taking out a form of revolving credit. When you have revolving credit, a financial institution agrees to loan you a specific amount of money every month (or another time period, depending on your agreement), which you can choose to use to pay for certain items in your day to day life.
Each month, however, you must pay off the balance or “revolve” the debt, making a minimum payment to carry over that debt to the next month. When you pay off revolving credit on time each month, there is no additional interest charge, BUT, if you choose to revolve your debt (i.e. “carry a balance”), you will be liable not only for the money you owe, but for the interest rate as stated in your credit card service agreement.
Why you need credit
To many people, the idea of regularly borrowing money or being in debt to another person or financial institution makes their stomachs churn. That sentiment is understandable: no one wants to owe anyone anything, so why would we ever choose to owe someone money on a regular basis?
It turns out that, with responsible use, credit is actually a really good thing. If you manage to build up good credit with financial institutions, over time, you’ll get a reputation as a responsible borrower who deserves lower interest rates.
This might not seem important to you yet, especially if you’re just starting out on your personal finance journey, but with time, you’ll probably find that you want to take out a loan to get a car, a mortgage, or to go to college. Additionally, should something ever happen and you need to borrow money in an emergency, with a good credit history, lenders will be more sympathetic to your cause and help you out with better terms of service.
Ultimately, revolving credit is something you want to have an excess of but to hope to never have to use. At the end of the day, we should all strive to pay off our credit cards in full at the end of every month, keeping the amount we actually owe to an absolute minimum.
How is a credit card different from a debit card?
At this point, you probably understand the benefits of having credit, or, more specifically, a credit card. But, you might still be a bit confused as to how a credit card differs from other forms of payment, such as a debit card.
Quite simply, a debit card is a payment method that is directly linked to your checking account. Debit cards are effectively a replacement for checks in our daily lives.
Back in the day, people used to write checks for everything, from their groceries to their restaurant bills. Debit and credit cards have long since taken over as the primary form of payment in nearly all life circumstances (besides those where you would use cash or bank transfers) as they provide a more secure method of instantly transferring money from one account to another.
Basically, when you pay with a debit card, the money comes directly out of your checking account. You aren’t borrowing money from anyone and your card will actually be declined if you try to spend more money than you have.
With a credit card, on the other hand, you can spend up to your monthly credit limit without having that money in your bank account. Effectively, you’re borrowing that money from your credit card company each month until you pay it off.
How does a credit card work?
Now that you understand what credit is, let’s start getting into the nitty-gritty of how credit cards work. Here’s what you need to know:
Making purchases with a credit card
Even if you’ve never had a credit card before, chances are pretty high that you’ve seen someone, whether it’s a parent or a friend, make a purchase with a credit card at some point in your life. As children, we remember being very confused by credit cards, once asking our parents if the meal we had just eaten was free because we saw them hand the waiter a piece of plastic instead of some money…
It turns out, however, that making a purchase with a credit card is purposefully super simple. Once you open your account and get your credit card in the mail, all you have to do is swipe, insert, or tap your card at a credit card machine to make a purchase. It’s as simple as that!
As you might imagine, the simplicity of the whole process is one of the many reasons why so many people end up with so much consumer debt (more on that later). But, this simplicity is also one of the many reasons why people love credit cards and why you should have one in your life.
When used responsibly, credit cards can make your everyday purchases so much simpler and, in many countries, cash is being phased out to make room for increasingly digital payment options, so without one, you’ll soon be left behind!
Paying a credit card bill
If you’re not like us as children and you understand that purchases made with credit cards are not, in fact, free, you won’t be too terribly shocked when you get a credit card bill in your postbox or inbox at some point after opening your first account.
Paying off a credit card bill is something you should strive to do every single month as it eliminates the possibility that you’ll need to pay interest on your purchases. When you receive that credit card bill, you’ll have the option to pay either:
- the credit card minimum
- the balance in full
- an amount between the minimum payment and your total balance
While the only way to avoid paying interest rates is to pay your balance off in full every single month. Understandably, there will be times in your life where this won’t be possible, due to a change in your financial situation or an economic emergency. But, if you strive to pay your full statement balance on time every month, you’ll probably find yourself in a strong financial position.
Automatic bill pay
If you want to be sure that you don’t miss a payment (some of us are just forgetful like that), a great way to avoid late fees and paying interest on your credit card is to set up automatic bill pay with one of your checking accounts. These days, nearly all credit card companies allow you to set up “recurring payments” that can automatically pay your full statement balance off each month on your due date.
When you do this, you effectively treat your credit card as a debit card, limiting yourself to only spending the money you have. We highly recommend taking this route with your credit card spending as it severely limits your ability to take on unnecessary consumer debt that will impact you for a long time to come.
That being said, if you do set up automatic bill pay for your credit cards and find that you need to carry a balance for whatever reason, be sure to turn off these payments or you might overdraw on your checking accounts!
Getting a credit card that’s right for you
Once you decide that it’s time to open a credit card, you now need to understand the different types of credit cards that are available to you. Then, it’s time to choose a selection of credit cards to apply to and hope for the best. Before you go down that rabbit hole, however, here’s some need-to-know information about getting a credit card that’s right for your needs.
Types of credit cards
Not all credit cards are created equal. In fact, many of the most popular credit cards offer a variety of rewards and other perks that make opening that particular card more attractive to people with good credit histories. Here are the different types of credit cards you’ll encounter on your search:
Basic/low-interest credit cards
Basic and low-interest credit cards offer little more than a plastic card to pay with at storefronts and a monthly revolving credit line. These cards are pretty bare-bones and have none of the perks and frills traditionally associated with “rewards” credit cards.
This might sound boring and not very fun, but basic credit cards are the perfect starting point for any new credit card holder. Basic cards tend to have lower entry requirements, lower initial interest rates, and more leniency when it comes to accepting applicants with minimal or poor credit history.
So, if you’re new to the credit card game, this is where you’ll start.
Student credit cards
While most credit applications require you to input information about your current employment status and income, many banks recognize that students, although technically “low income” at the moment, are investing in themselves and are likely to have higher incomes after graduation. Many students find that student-specific credit cards are a great option for them as they often offer low fees and low-interest rates in a convenient, simple-to-use package.
However, just because you’re a student doesn’t mean you’ll automatically get approved for that student credit card. In fact, the Credit Card Act of 2009 explicitly prohibits financial institutions from approving people under 21 for credit cards unless they have a co-signer or proof of income. So, if you have trouble getting approved for a student credit card, you might want to try a secured credit card, instead.
Secured credit cards
If you have a bad credit score (more on what that means later) but want to work on building up your credit again, a secured credit card is a great choice. In exchange for offering you credit, despite your poor credit history, secured credit cards require that you put down a security deposit (the amount varies) when you open the card.
When you close your secured credit card or upgrade to a regular credit card, you automatically get your security deposit back, unless you have an unpaid balance. Secured credit cards are a great way to build credit when you’re not able to get approved for a regular card, especially if you’re younger or looking to restart your financial life.
Rewards credit cards
Rewards credit cards, the veritable fan favorite of any credit card option, is a kind of credit card that gives you some sort of bonus every time you make a purchase. Often, these cards give you airline miles, in-store discounts, or other such benefits simply for buying things with that credit card.
The vast majority of rewards credit cards are either travel cards, cashback cards, or store credit cards (such as those for Target and Best Buy), though there are others out there. Rewards credit cards can be great for anyone that frequently spends a lot of money on credit (hopefully you pay it back each month!) as you can basically get free stuff for your normal spending habits.
However, the vast majority of rewards credit cards require that you have good to excellent credit already established. Plus, many of the best credit cards come with annual fees (especially airline credit cards), so you need to spend a lot to make it worth the money.
Choosing a credit card
With all of these different credit card options to choose from, it’s easy to feel all overwhelmed by all of your options. However, if you’re just starting our on your credit card career, chances are pretty high that your decision has more or less been made for you as you’re probably limited to a basic, student, or secured credit card for the time being.
That being said, even within those categories, there are a lot of great options to choose from, so you still have some searching to do. Here are some of the top things to look for when choosing a particular credit card to apply to:
- Look for low-interest rates. Especially when you’re just starting out, getting a credit card with the lowest possible interest rate can make it easier on you should you ever have to carry a balance.
- Find a card for your credit history. If you don’t already have a credit history or your credit score is poor, you’ll want to target your search to those credit cards that are made for people in your situation. Googling “credit cards for bad or no credit” is a good way to get started.
- Seek out sign-up bonuses. If you’ve got good enough credit to qualify for a rewards credit card, a sign-up bonus is a great incentive to apply. While we don’t recommend applying solely for the sign-up bonus, it can sway your decision when you’re stuck between two great choices.
Need-to-know credit card information
While credit cards sound great, it’s important to understand that overwhelming consumer debt has and continues to ruin a lot of lives. Thus, anyone interested in opening a credit card account should thoroughly understand the basics of credit cards and how to use them appropriately.
We here at Freelance Finance firmly believe that appropriate knowledge about how credit cards work can help people avoid the trap of credit card-related consumer debt, so here’s the information you need to know:
Understanding the credit card terms and conditions
Although many of us are quick to skip over the terms and conditions agreement of nearly every single thing that we sign up for, when it comes to financial products, like credit cards, it’s definitely worth your time and energy to read this document thoroughly. Even if you don’t quite yet understand all of the technical jargon involved with the terms and conditions of your credit card, the more you read these things, the more likely it is that you’ll learn more about how it all works.
The terms and conditions agreement of your credit card is worth reading because it often contains valuable information about the rates and fees that you agree to when you open the account. While some of these fees are advertised when you research the account, some are kept purposefully hidden to trick and confuse consumers. Here are the top things to look out for:
What is APR?
APR – or annual percentage rate – on a credit card is effectively the interest rate that you agree to get charged with, should you not make your payments in full or on time. This rate varies greatly from credit card to credit card, and you’ll often find that credit card terms and conditions will give you a range of APRs available for that particular card.
Each financial institution assigns you an APR based on your individual creditworthiness (i.e., your credit score and history) and the type of card you’re trying to open. Rewards credit cards often have the highest APRs, while basic credit cards have the lowest.
If you open a card and get smacked with a high APR, don’t despair. Many companies start you out with a high APR, but with regular, reliable payments, you can often ask to lower your APR after a few months.
What is a credit limit?
Perhaps the first thing you’ll notice after you open a credit card is that you’ll have a specific “credit limit” available to you. Basically, a credit limit is the amount of money you can borrow each month on your card.
This credit “revolves” and resets each month, so if you have a credit limit of $1000, you can spend up to that amount in January, and it will reset so you can spend up to $1000 in February. Should you try to spend more than $1000 in January, your card will be declined.
Your credit limit is determined by your creditworthiness, but once you start opening a few different accounts, you’ll probably find that there’s not a lot of rhyme or reason to the game of credit limits. If you have poor credit, you’ll probably get a low credit limit initially. But, if you have excellent credit, you’ll find that some card issuers give you a high credit limit while others give you relatively little.
Our advice? Be responsible and try to minimize your credit card use. Don’t “max out” your credit cards by spending your limit each month. Instead, opt to spend 30% or less of your available credit.
What are credit card fees?
Even if you have a basic, low-interest credit card, you’ll have a whole host of fees listed on your credit card terms and conditions. These are the most common fees you’ll find:
Many credit cards, especially rewards cards, come with annual fees that range between $25 and $500. Generally, the better the rewards, the higher the annual fees, though this isn’t always the case. If you’re paying more than $150 for an annual fee, your card probably comes with some swanky benefits, like airline lounge passes, that make the fee well worth it. However, most basic and student cards have no annual fee, which is a good choice for the vast majority of people.
Foreign transaction fees
Unless you get a travel credit card, chances are very high that your card will charge a “foreign transaction” fee for any purchases made outside your home country. If you travel a lot, this is a huge pain as these fees are often in the 3-5% range. This is why travel credit cards with no foreign transaction fees are a huge bonus.
Cash advance fees
In some instances, you can use your credit card at an ATM to take out cash in a move known as a “cash advance.” When you do this, you’re often limited to about $200 a month and charged an additional fee for the convenience.
Understanding your credit score
Once you apply for your first credit card, you’ll have access to information about your credit score (you can look up this information earlier, but it’s not necessarily worth it until you start taking out credit). A credit score is basically a three-digit number that quantifies your creditworthiness to lenders who use this number to decide if they want to lend you money.
Credit scores are actually surprisingly complex, and the methods used to calculate them aren’t 100% public information. Since credit scores are calculated by credit bureaus, you actually have three different scores that an institution can use to asses your creditworthiness.
For the most part, making your monthly payments in full and on-time is a great way to build your credit. Keeping the amount of revolving credit you use each month to a minimum (about 30% of your credit limit) is also a good move. It’s also important to keep the number of credit applications you make to a minimum as multiple applications make lenders think you’re looking to take out more credit than you can handle.
Since credit scores are such a tricky concept, we’ve dedicated a whole article to learning more about them, which you can check out right here.
Applying for your first credit card
Okay, at this point, you’ve got a pretty darn good understanding of the world of credit cards as we’ve discussed everything from why you need credit to the kinds of credit cards you might be interested in. Now that you’re a knowledgeable potential credit card owner, it’s time to get you that first credit card.
The credit card application process
Although it sounds scary, applying for a credit card is actually quite simple. Here’s what will happen:
- Make a list of the top five credit cards you’d like to apply to, starting with the option you’re most interested in.
- Collect all of your personal financial information, including your social security number, your current income, your employment status, and the like.
- Click “apply” on the credit card information page and fill out the form using this information.
- Read and understand the terms and conditions
- Press “submit” and hope for the best!
- Hopefully, your application is automatically approved and you can celebrate.
- If your application is not automatically approved, one of two things can happen: you can be denied or deferred. If you’re denied, you can go ahead and repeat the process with another credit card on your list. If you’re deferred, the credit card issuer has flagged your application for additional review by an actual human being, who will review your case and see if you’re trustworthy enough to open an account. Often, you will be contacted by phone or email for more information. If you are ultimately denied, you can go ahead and apply for a different card.
Credit card pitfalls
Credit cards are awesome, though they’re often misused and abused to the point that they become unsustainable or even detrimental to an individual’s financial health. Here are some of the most common credit card pitfalls we see that lead to overwhelming amounts of consumer debt:
- Not paying off balances in full. If you’re struggling to pay off your balances each month, take the time to reflect on why that is. Is it because you’re in a difficult spot and need to borrow money? Or is it because you’re buying things you just can’t afford. If it’s the former, perhaps consider getting a loan with a better rate than your credit card. If it’s the latter, then you may need help managing your spending habits.
- Opening too many cards. Many people are tempted by sign-on bonuses and other similar marketing gimmicks that encourage them to open more credit cards than they can truly handle. If you’re feeling like the number of credit cards you have is making it difficult to keep track of your spending, consider closing a few accounts.
- Ignoring fees. Should you choose not to read the terms and conditions of your credit card, you may not realize that your card comes with a whole host of fees that are getting tacked onto your bill each month. Whether it’s a foreign transaction fee or an annual fee, these payments add up and can do damage to your financial health.
- Forgetting to make a payment. Despite your best intentions, you may forget to make a payment every once in a while. At the very least, it’s worth setting up auto-pay on your cards to ensure that you make the minimum payment on your card each month to avoid additional fees.