Credit cards, like any financial instrument in society, have a purpose. That purpose will vary from person to person but usually revolve around a select few: making purchases with money you don’t have, building your credit history and score, and rewards. Because your credit score has such an impact on your life, including a home purchase or even the job you applied for, credit cards should be used as a tool to improve it.
What is a credit card?
A credit card, essentially, is a way to make purchases with borrowed money. The amount you are allowed will vary by certain factors, but the two main factors are credit score and income. More often than not, people with higher scores and higher income will qualify for a higher credit limit.
The debt, however, will need to be paid back. If you pay back the borrowed amount in full by a certain date, then all you owe is the amount borrowed. However, if you pay after the due date or only pay the minimum, you will most likely owe interest. When interest is added on, it increases the total amount you owe, which means it costs you money to borrow money.
The interest rate charged could vary depending on if there is a change in the base rate called the prime rate. If the prime rate increases by 1%, your credit cards interest rate will likely change as well. If this is the case, your card is set up as a variable rate, and these are most common among credit cards.
Types of Cards
There are many different types of credit cards to choose from, and the one you pick should meet your individual needs.
- Rewards cards – these are for people looking to for something in return. The most common types of rewards cards are travel rewards (give you miles with certain purchases), cash back cards (give you a certain percent cash back on certain purchases), and rewards points (give you points to be redeemed on various items).
- Balance transfer cards – most cards offer the ability to transfer a balance from another card, but these cards usually offer a 0% rate on balance transfers. The length of the offer can vary from 6 months to 21 months.
- Prepaid/secured card – as the name implies, a prepaid or secured card has a credit limit that is set by an amount you deposit up front, usually a couple hundred dollars. This type of card is for people with poor credit or those with little or no credit history.
- Store/gas cards – these types of cards are limited to where they can be used. Most retail stores will offer cards for a percentage off of purchases, only to be used at that retailer. Gas cards typically offer points, and like the store card, only to be used at individual gas stations.
How do I pick one?
The short answer is you should get whatever credit card suits your needs. If you travel a lot and are looking to get extra miles, get a travel rewards credit card. If you have poor credit or no credit, get a secured card. If you have little self-control or don’t trust yourself with a credit card, get a prepaid card.
Credit cards can be a very useful tool to have in your financial tool belt if used correctly. When using credit cards, however, proceed with caution because it is very easy to spend out of control and bury yourself in debt.
As always, for specific and personal financial advice, consult with a financial professional.
For more information about credit cards, I strongly recommend visiting Nerdwallet.com.