Your credit score is important. It determines everything from employment to whether you can rent an apartment or get a cell phone. Consumer debt is a very real part of life, averaging more than $90,000 per person. It’s important to learn how to protect your credit score so that when you need to borrow money, you will qualify for the best interest rates available.
In this article, you’ll learn the basics of how credit and credit cards work, the advantages and disadvantages and the best ways to use them.
What are the Advantages of Credit?
Good credit means lower APR, fewer finance charges or penalties on existing accounts and better approval odds for other loans. It will help you pay less for some products like car insurance. It also means faster approval times for new loan or credit card applications.
There are a few other benefits, including:
- The option to use a lender or financial institution’s money for things that cost a lot
- With a credit line, the flexibility of using something while you pay for it rather than having to wait until you can afford it
- Ability to take advantage of certain sales and deals
- Ability to build your credit history and credit report for better loan products and higher approval ratings in the future
Here are nine great benefits you can get if you have a good credit score:
What are the Disadvantages of Credit?
- High credit limits encourage poor spending habits and may lead to more debt
- It almost always ends up costing extra money in the form of interest charges
- Overuse, or high credit utilization, leads to a poor credit record
- A poor credit score may make it difficult to find and choose the best prices or loan options
- Low credit limits future buying power
Advantages of a High Credit Score
Having a high credit score brings many advantages (and no disadvantages). They include:
Lower Interest Rates
When you pay bills on time, you show lenders that you’re responsible. In turn, lenders will recognize your pattern of responsibility by offering better interest rates. This means whatever you borrow will cost you less over time.
Higher Credit Limits
Your credit limits will likely be higher, which in turn will help your credit score, because it will keep your credit utilization ratio low.
A Better Shot at a New Job
More than half of employers routinely check credit reports to ensure there are no black marks. While prospective employers won’t see your birthdate or credit score, they will see any open lines of credit (such as mortgages), outstanding balances, student loans, auto loans, bankruptcies, foreclosures, late or missed payments, charge-offs or accounts in collections.
Better Rewards and Incentives
Many of the cards with the best travel incentives or cash back bonuses are premium cards, reserved for those who have the best credit scores.
More Purchasing Power
If you’re shopping for a home or car, it’s simpler to get prequalified or pre-approved by lenders. Pre-approval gives you more negotiating power. Some home offers won’t even be considered if the potential buyer isn’t already pre-approved for a mortgage.
Don’t take your credit score for granted. People with better credit scores and blemish-free credit reports have a lot of advantages over those whose credit scores are less-than-ideal.
Advantages of Credit Cards
Credit cards can be very useful when used correctly. One of the biggest (and most obvious) advantages of credit cards is that they’re a convenient way to cover small expenses and financial emergencies. In addition, a credit card makes it easier if you need a rental car, or to book a plane ticket. However, there are also several lesser-known benefits to using a credit card. These are:
- Build credit. Establish or repair credit with a credit card by making on-time payments every month. Many credit cards also include a free credit score to make sure you’re on track.
- Security and fraud protection. Credit cards are a secure way to make online purchases. By federal law, a credit card issuer cannot charge you more than $50 for any fraudulent charges made on the card. Many issuers offer complete fraud protection, provided you report the unauthorized charges within a few days or weeks.
- Earn rewards. Many credit cards offer cash back rewards, travel points or miles, and shopping benefits. Other rewards include cheaper travel insurance and a collision damage waiver on vehicle rentals.
- Interest-free “loans.” If you pay off the balance in full every month, credit cards also act as interest-free “loans.” This is because they only accrue interest or other fees when there’s a balance on them at the end of the month.
- Interest-deferment. Some credit cards are interest-deferred for some time – usually up to a year. During this period, the card will not accrue interest even if there’s a balance on it. This can be useful if you need to make a larger purchase (ex. desktop computer) and can’t pay it off at that moment. However, if you don’t pay the balance before the period ends, you will be hit with the interest.
- Debt consolidation. Certain credit cards, such as 0% balance transfer credit cards, are good for debt consolidation. These cards take existing debt across different lines of credit and consolidate them into a single, low-interest card.
- Price, purchase, and return protection. Price protection helps ensure you pay the lower price for whatever item you buy, even if the price increases elsewhere. Purchase protection secures new purchases from theft or damage for the first few weeks or months. Return protection lets you get a refund for an item, even if the retailer doesn’t typically allow it. Not all credit cards offer these, but some do.
- Extended warranty. Some credit cards come with extended warranty coverage that lasts up to two years, depending on the issuer. This warranty protects purchases beyond the manufacturer’s warranty.
Although credit cards come with many advantages, assess your financial situation before applying for one. Ask yourself:
- Will I use the credit card responsibly?
- Can I afford to repay any purchases I make on this card, with interest?
- Can I pay off the balance on time and in full every month?
Not all credit cards offer the same benefits or rewards, so shop around before choosing one.
Disadvantages of Credit Cards
Credit cards also come with their share of disadvantages. For example, they could:
- Promote overspending, which can leave you stuck with a high credit card balance and a load of credit card debt.
- Require you to have established creditworthiness to qualify (this usually requires proof of sufficient income and a minimum credit score)
- Come with interest, which adds up quickly if you don’t pay the balance in full each month
- Come with other fees (ex. late or missed payment fees, annual fees, balance transfer fees)
- Damage your credit if you’re frequently late on payments or have a high credit utilization
- Be subject to fraudulent charges or illegal transactions which could be stressful even when reimbursed
How to Use Credit Cards Strategically
Using a credit card is easy. For in-person shopping, you may be able to add the credit card to a digital wallet for contactless payment. For online purchases, all you need to do is enter some basic information such as:
- Card number
- The expiration date on the card
- Card’s CVV security code (three-digit number on the back of the card)
- The card’s ZIP code
Unfortunately, sometimes credit card use can be too simple, making it easy for cardholders to run up debt without realizing it.
In one recent transaction, a shopper spent nearly $1,200 without even having to show a credit card while shopping at a furniture store. In less than five minutes a line of credit was approved, the purchase made and delivery scheduled. There’s a reason the process is so simple. It is easy to lose track of spending or get carried away when you don’t even have to swipe a credit card at the cash register, particularly when the retailer is offering an incentive, such as 12 months with no interest. You don’t know what could be hidden in the fine print, because you never even see the loan agreement.
Using Credit Cards to Build Credit
One of the biggest advantages of using a credit card is the opportunity to build or repair credit. Here’s how to do it.
Pay Bills on Time
To build credit, you need to make payments to a lender that reports those payments to the three credit bureaus. These bureaus are TransUnion, Equifax, and Experian.
Some companies, like utility or phone companies, won’t help build credit because they don’t report payment activity to the credit bureaus. With a credit card, however, you can build credit by making on-time payments to the account and keeping it in good standing. This is because credit card issuers report to the credit bureaus.
That said, if you’re late on a payment by more than 30 days, the credit card issuer will also report that to the credit bureaus. If you frequently miss payments, however, your account could end up in collections. This would damage your credit score.
Know the Interest Rate and How it’s Calculated
Most financial products, including credit cards, come with interest or an APR (annual percentage rate). The average APR on a credit card is between 14% and 16%. This percentage may be lower if you have a higher credit score. Or it may be higher if you have a lower credit score.
Here’s an example of how APR on a credit card works, according to the U.S. News and World Report:
- Credit card’s APR: 16%
- Balance: $1,000
- Payment period: 6 months
- Total interest: $47
If the APR on that same card was 20% instead, then the total interest would be $59 over the 6 months.
Although this may seem like a small difference, it can become quite significant with a higher balance or APR. For example:
- Credit card’s APR: 16%
- Balance: $10,000
- Payment period: 2 years (24 months)
- Total interest: $1,750
That same balance on that same card with 20% APR would cost around $2,215 in interest.
That’s why, if possible, you should pay the balance in full every month. That way, you won’t have to pay anything in interest.
Know Your Account Balance
The balance in your account isn’t necessarily representative of what you’ll end up paying. Besides interest rates, keep an eye out for other fees such as:
- Late fees
- Annual fees
- Balance transfer fees
- Cash advance fees
- Returned transaction fees
- Foreign transaction fees
These can add up quickly and cause the total amount owed to be much higher than expected.
Manage Your Credit Cards Wisely
It’s tough to juggle multiple credit cards at once. In fact, the average American has four credit cards with an overall balance of $5,313. Paying them all off requires discipline, strict money management, and good budgeting skills.
Still, if you can manage credit cards, they can have a positive impact on your credit. Here are the main effects of credit cards on a credit score:
- Average age of credit. This makes up around 15% of your credit score. Keeping older accounts open and in good standing could give your credit score a boost.
- Credit utilization. This accounts for up to 30% of your credit score. By keeping your credit utilization ratio below 30%, you can increase your credit score.
- Payment activity. All payment activity, including on-time and missed payments, accounts for up to 35% of your credit score. More recent activity has the highest impact.
- Debt-to-income (DTI) ratio. This doesn’t directly impact your credit score, but it could impact whether a lender approves your loan application. Also, having a high DTI ratio could make it harder to pay off existing debt.
If you’re getting your first credit card, check with your local bank, credit union, or online lender for one without annual or maintenance fees. Look for a card with good rewards, too.
- Chase Freedom Unlimited. 5% cashback on certain purchases, no annual fee, 0% intro APR
- Discover It. Up to 5% cashback per quarter, no annual fee, 0% intro APR
- Capital One Quicksilver. 3% cashback, $200 rewards bonus, no annual fee
If you already have a credit card and want to get a new one, it’s a good idea to keep the older accounts open. That way, you can build the average age of your credit history, which helps improve your credit score. You may need to use the older card once or twice a year to keep the account active and prevent the issuer from closing it though.
Credit Cards vs. Debit Cards: What’s the Difference?
Here are some key differences between a credit card and a debit card:
- You may be able to get a cash advance or balance transfer with a credit card (for a fee).
- While a debit card may be branded MasterCard or Visa, a debit card does not help build credit.
- Since a credit card is a loan, the issuer will charge interest. Debit cards use your own money and do not charge interest.
- Debit cards are linked to your checking account and often come with hefty overdraft fees and account maintenance fees.
- Credit cards may have annual fees, administrative fees, late payment fees, rewards program fees, and other penalties.
- Credit cards are a more secure way of shopping online.
- A debit card may require more time to process transactions. For larger purchases, the bank may put a temporary block on the card.
What Types of Credit Cards are Available?
- Secured credit card: A secured credit card requires you to make a cash deposit (usually between $200 and $2,000) that serves as your line of credit. You may then use the card and make monthly payments to the account as usual. The credit card issuer will report any payment activity to the credit bureaus to help build credit. With time, it may be possible to convert a secured credit card to an unsecured one.
- Unsecured credit cards: With a traditional, or unsecured, credit card, you’ll receive a maximum line of credit based on your creditworthiness. This card also helps build credit.
- Low balance transfer offer credit cards: This card allows you to transfer the balance from one credit card to another at a minimal cost. Usually, the new card has a lower interest rate, which can make it easier to pay off the balance. The drawback is that you’ll need a fairly good credit rating to qualify for these offers.
- Rewards credit cards: These credit cards offer different rewards (ex. travel miles or cash back) when used. Most modern unsecured credit cards are also rewards credit cards.
- Charge cards: Charge cards are similar to traditional credit cards and help build credit. However, you must pay the balance off in full every month. Charge cards may also come without a preset spending limit. They often come with annual fees, late payment fees, and other fees.
Will I Qualify for a Credit Card?
There are two types of credit scores: FICO and VantageScore. Potential lenders may use either score to determine an individual’s eligibility for a credit card, loan, or other financial product.
To get a FICO Score, you must have an existing account (line of credit, student loan, etc.) that’s at least 6 months old. For a VantageScore, you can qualify if you have one valid account, regardless of age.
Both FICO and VantageScore (3.0 and 4.0) range from 300 to 850. For FICO, this score is determined by:
- Payment history (35%)
- Credit utilization (30%)
- Average length of credit (15%)
- Diversity of credit (10%)
- New credit (10%)
The breakdown of the score may vary for VantageScore, but the same factors apply. In both cases, the higher the score, the better. In general, here’s what the scores mean:
|FICO score range||VantageScore range|
|Excellent credit||800 and up||781 and up|
|Very good credit||740 to 799||661 to 780|
|Good credit||670 to 739||601 to 660|
|Fair credit||580 to 669||500 to 600|
|Poor credit||300 to 579||300 to 499|
To qualify for the best credit cards with the best rates, you’ll need a 700+ credit score. If you have a credit score in the 600s, you may still qualify for a credit card but at much higher interest rates.
What If I Don’t Qualify for a Credit Card?
If your credit card application is declined, you might need to do some work to improve your credit before you try again. There are a few ways that you can work to boost your score.
Use Your Monthly Subscriptions
Everything is subscription-based these days, and you can use your subscriptions to various streaming services, like Netflix or Hulu, or other recurring charges like phone bills to boost your credit score. Here’s how:
- Sign up for Experian Boost
- Set up subscriptions to be charged to a credit or debit card
- Register that card with Experian Boost
- Set up your bank account to automatically pay off that card each month
READ MORE: How to Use Subscriptions to Build Credit
What is a Credit-Builder Loan?
A credit-builder loan is a good way to build or establish credit. Some online lenders, credit unions, and community banks offer these loans to borrowers with poor credit. It works like this:
- The financial institution sets aside a preset amount of money in an account or Certificate of Deposit (CD).
- You make monthly payments until the loan is repaid. Payments include the principal balance and interest.
- The lender reports all payments to the credit bureaus to help you build credit.
Two of the best credit-builder loan lenders are Self and Chime.
- Has four credit-builder plans with varying terms from 12 to 24 months
- Plans range from $25 to $150 a month, but most of this money is returned to the borrower upon successful repayment of the loan
- One-time, $9 administrative fee
- Interest rates range from 12.44% to 14.87%
- Reports to all three credit bureaus
- Offers a flexible credit-builder card and account
- Borrowers may transfer as much as they choose to the account
- Monthly installments required to build credit
- No annual fee, interest, or foreign transaction fees
- Reports to all three credit bureaus
Don’t Try to Juggle Too Many Credit Card Accounts
Whether you’re getting your first credit card or thinking about adding a new account to an existing mix of credit, avoid applying for multiple accounts at once.
Credit card applications result in hard inquiries, which can cause a temporary drop in your credit score. Some lenders also use the number of applications as part of their qualifying process. Too many applications may mean outright rejection.
For instance, Chase Bank will automatically reject an application from anyone who has received five credit cards in the past 24 months from any lender. This is known as the 5/24 rule.
Sometimes the only way to improve your credit score is to be patient. Eventually that black mark will fall off, and if you keep everything else on track, your score will start to increase. But a series of missed payments in the past 12 months will hurt your score more than a series of missed payments three years ago with a record of on-time payments afterward. There is no miraculous way to make those black marks disappear, and anyone who tells you they can make them disappear (if you pay them, of course) isn’t being entirely truthful.
The Bottom Line
Credit has many advantages and people with higher credit scores will always qualify for better — and bigger — loans. Even if you’re struggling financially, do whatever you can to make your minimum monthly payments so that your credit score doesn’t go off track during your financial setback.
No. Before applying for a credit card, make sure you can afford it and that you’re using it for the right reasons – for example for building credit or financial emergencies. Cashback and other rewards should be perks, not the sole reason for opening a new account.
A “grace period” is the time between the due date on the credit card and the end of the billing cycle. If you pay the full balance by the due date, the account will not accrue interest, usually at high interest rates.
If you notice fraudulent activity or charges on your account, call the credit card company immediately and let them know. They will close the account and issue you a new credit card with a different number. Oftentimes, you will not be charged.
Credit union cards have lower interest rates and fewer fees than traditional credit cards. They also come with extra rewards like access to the private airport lounge or cash back. It may be easier to qualify for this type of card if you’re a member of a credit union.