Credit Card Basics—How To Use a Credit Card Responsibly
According to TransUnion, the number of credit card users rose to 166 million in Q4 of 2022, marking a notable increase from the previous three years. Despite the widespread popularity of credit cards, many users fail to use this payment method properly and succumb to debt.
For the first time in history, the total credit card debt in the U.S. surpassed $1 trillion, as reported by the Federal Reserve Bank of New York. One thing you can do to avoid becoming part of this alarming statistic is familiarize yourself with credit card best practices. That way, you can reap the card’s benefits while minimizing the risk of financial pitfalls.
This article aims to educate you on proper credit card use. Besides answering how to use a credit card responsibly, you will also learn:
- Why is it important to use a credit card properly?
- What are the dangers of using credit cards online?
- What is the safest way to conduct purchases with credit and debit cards?
What Is a Credit Card?
A credit card is a type of payment card issued by financial institutions such as banks and credit card companies. With this card, you can borrow funds up to a certain limit and use them to make purchases and other transactions.
While debit cards require you to keep money in your account and draw funds directly from it, credit cards allow you to borrow funds and repay them later, usually on a monthly basis. For this reason, many consumers choose to use credit cards for emergency expenses when they don’t have the cash on hand.
Besides the borrowed amount, you may also be required to pay any applicable interest and additional agreed-upon charges, either in full by the billing date or over time.
Credit cards come with many advantages:
- Credit score building—A credit score is a number representing your creditworthiness. It’s calculated based on several factors, such as your payment history, credit utilization ratio, and credit history length. The higher the credit score, the higher your chances are of securing low interest rates and favorable lending terms.
- Reward programs—Credit cards typically have various reward programs catering to different spending areas. The rewards include redeemable points, cashback for certain purchases, and travel perks.
- Credit card protection programs, such as purchase and fraud protection—Credit cardholders can file a dispute for unauthorized or wrongful billing, such as in the case of undelivered or damaged goods and fraud.
The Importance of Using a Credit Card Properly
When spending with a credit card, you typically have to repay borrowed funds monthly before the specified due date. The total amount of borrowed funds you must repay is called the balance. If you don’t pay off the balance in full before the due date, you’ll likely be charged interest. That means you’ll need to pay more than you initially borrowed from the credit card issuer, usually a predetermined percentage of the total. An unpaid balance carries over from month to month, accumulating interest and debt.
High interest and debt can have many consequences for the cardholder, such as:
- Negative impact on credit score
- Limited financial freedom and lack of stability
- Difficulty acquiring new credit or loans
- Legal consequences, i.e., court proceedings and potential asset loss
- Long-term consequences, such as the inability to save for retirement
- Emotional distress
How To Use a Credit Card Responsibly
If you learn how to use a credit card wisely, this payment method can offer substantial benefits. Responsible use of a credit card entails:
- Choosing the right credit card
- Paying off your balances on time
- Staying within your budget
- Working to increase your credit score
- Tracking account activity and detecting possible fraud
Choosing The Right Credit Card
You should carefully research your options to find the optimal credit card that fits your lifestyle. Start by observing your spending habits. You should identify where you make purchases frequently and what you spend money on most. Select the card that offers rewards for such transaction types or merchant categories. For example, if you travel often, a card with travel rewards like airline miles and hotel discounts might be the best choice for you.
Another factor to consider is the card’s eligibility criteria. Some credit cards, especially those with generous reward programs, entail stricter criteria, such as a higher credit score. In any case, you must be over 18 years old and have a steady source of income.
It’s important to read the terms and conditions before settling on a card. Check its interest rates, payment due dates, and fees, ensuring they align with your financial capacity and spending habits. For instance, if you shop outside of the U.S. frequently, you may want to choose a card with low or non-existent foreign transaction fees.
Although many credit card providers offer rewards and introductory bonuses, it’s necessary to read the fine print. In order to qualify for most introductory offers, you need to spend over a certain amount in a relatively short period of time. Before jumping on this kind of offer, be sure you can not only spend the minimum amount but also pay it back on time.
Paying Off Your Balances on Time
One of the most crucial responsibilities of credit cardholders is paying off statement balances in full each month before the due date. As payment history makes up 35% of your credit score, missed payments can severely impact your creditworthiness. Even a single late payment can cause significant issues, leading to:
- Penalty fees
- High interest
- Accumulation of debt
Many issuers provide a grace period, which is an additional period after the cycle’s due date, during which you won’t be charged interest or fees. However, if you miss payments, you run the risk of losing this benefit. To stay on top of your payments, consider setting up auto-pay or create reminders on your phone.
A common misconception among inexperienced cardholders pertains to minimum payments. Issuers calculate the minimum payment based on monthly balances, which you must settle to fulfill the contractual obligation and avoid late fees. Although paying the minimum keeps you in good standing with your credit card company, the remaining unpaid balance will transfer to the next month with interest, resulting in a higher payment down the road.
Staying Within Your Budget
All credit cards come with a limit. If you exceed it, your payment could be declined. You may also be subject to over-limit fees, interest, or even account closure. You should not only avoid exceeding the limit but also aim to use as little of your credit as possible. This advice is based on the credit utilization ratio (CUR).
The credit utilization ratio is the second most impactful credit score factor after the payment history. The CUR compares the amount of credit used to the total amount of credit available. A common rule of thumb is to keep the ratio under 30% to avoid a negative impact on your score. Ideally, you should keep it under 10% for an excellent score.
To keep your CUR low and stay within budget, spend only what you can afford to pay back, abstaining from large impulse buys. Keep track of your credit usage with a budgeting tool and consider the mandatory monthly payments.
Working To Increase Your Credit Score
The first step to maintaining a solid credit score is understanding how it’s calculated. In the following table, you’ll get an overview of all credit score factors and how much they influence the total score: