Credit card usage is more common than ever. Knowing the right ways to use a credit card can help it become an important tool for your finances. Learning the facts about credit cards is important to steering clear of frequent errors that can result in debt and a bad credit history.
1. You Always Get the Same Interest Rate
Your credit card’s Annual Percentage Rate (APR) is important in determining the interest you pay. Your card can have separate APRs for different types of transactions. Many cards have as many as three, with a separate APR for purchases, balance transfers and cash advances.
For instance, Tanya uses her credit card to buy $500 worth of goods. She also obtains a balance transfer of $250 and withdraws a $100 cash advance. Her card has a 15% APR for purchases, 10% APR for balance transfers and 20% APR for cash advances. She will end up with interest payments of 15% of $500, 10% of $250 and 20% of $100.
Sometimes, a credit card will have the same APR for two different types of transactions. However, there can still be a practical difference. A major one is that the interest fee grace period credit cards typically allow for purchases will not apply to interest on other transactions. Thus, you can start incurring interest on balance transfers and cash advances as soon as you complete the transaction.
2. Your APR Stays the Same
Complete information on how APRs work is a major part of facts about credit cards you should know. Another key aspect of APRs is that they can change. Your cardholder agreement may state that late payments will trigger a penalty APR. These rates can be as high as 30% or even more. This can happen even if you have a good payment history. It only takes one late payment to trigger the penalty APR.
Another thing to know about a penalty APR is that it isn’t just applied to the payment you were late on. Some credit card companies charge the high APR indefinitely. Others can set a specific time period during which you must make on-time payments before they revoke the penalty APR.
Another way your APR can change is if it is variable. This means it changes according to market fluctuations. Most credit card companies set their variable APR based on the Prime Rate. This rate corresponds to the corporate loan base rate officially posted by 75% or more of the largest 30 banks in the United States. This rate is not set by the government but it does tend to strongly correspond with the federal funds rate, usually staying three percentage points above it.
The federal funds rate and the Prime Rate can change based on the economy. There is no set schedule for these changes, which can happen at any time and with any frequency. Therefore, your APR can be subject to the same fluctuations.
3. Carrying a Balance Improves Your Credit
As many as 43 million Americans believe that carrying a balance is good for their credit score. This is one of the most persistent myths that contradicts the real facts about credit cards. Your credit score does not actually improve just because you have a balance. What actually affects it is the difference between your spending limit and your balance — the bigger, the better.
In addition to failing to improve your credit score, carrying a balance can also harm your finances. The higher a balance you carry, the more interest you pay on it. Plus, growing your balance also increases your utilization ratio, which actually decreases your credit score.
4. Rewards Are Worth the Additional Interest
Many credit cards offer a variety of rewards and incentives. Some of them are so attractive people open a new credit card just to take advantage. While this can be worthwhile, you need to be careful. If you end up carrying a balance rather than paying it in full every month, what you spend on paying the interest will likely overtake the rewards you get.
5. Canceling Unused Credit Cards Is Good for Your Score
Another common myth in circulation is that canceling credit cards you don’t use is a good way to improve your credit score. In fact, the opposite is true. As mentioned above, your utilization ratio is one of the factors that influences your score. Keeping cards open but not using them gives you an additional credit limit that you don’t fill up. It also helps your length of credit history, another part of your credit score. An old account may be giving your credit score a boost, even if you’re not using it. Only cancel these credit cards if it costs you money to keep them open.
6. Bad Credit Means You Can’t Have a Credit Card
Using a credit card and making on-time payments in full is one of the ways to improve a credit score. However, if you already have poor credit, you may believe this is not an option for you. It can be very hard to obtain a credit card with a low score, so many just resign themselves to using debit cards or prepaid cards. While these options enable you to make electronic transactions, they do not fulfill the credit-building function of a credit card.
Instead, you may opt for a secured credit card. Typically, this means you have to put down a cash deposit before you can get the card. You will likely also have a low limit on it. Making consistently timely payments on this card will help you improve your credit and eventually make you eligible for a regular card.
7. Using a Credit Card Is a Shortcut to a Perfect Score
Your credit card can be a valuable tool for improving your credit. However, it is not a magic fix. For most people, it takes a long time of on-time payments and low or zero balances to see an effect. You can look into other factors that go into building up a score.
If you need help with more than credit cards, like errors on your credit reports, Lexington Law Firm may be able to help you. Contact us today for a free personalized credit consultation to see how we can help you.
Article Updated June 27, 2019