Contents
Personal Finance Basics
How to Create a Budget
How to Save Money Effectively
How to Open a Checking Account
How to Manage Credit Cards, Charge Cards, and Debit Cards
How to Invest Your Money
How to Get a Loan
Personal Finance Checklist
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How to Manage Credit Cards, Charge Cards, and Debit Cards
Though people often use the term “credit cards” to refer to all of the plastic cards in their wallets, there are actually three different types of cards you can carry: credit cards, charge cards, and debit cards.
Credit Cards
Credit cards allow you to buy money with credit, or money that a bank loans to you. When you buy anything with a credit card, you’re using the bank’s money—not your own—with the expectation that you’ll pay the bank back eventually.
How Credit Cards Work
Credit cards do not require you to pay back the full amount you charge each month. Instead, you’re required to make only a minimum monthly payment that typically averages just 2–3% of your outstanding balance. You’ll then be charged interest on whatever portion of your balance you don’t pay off, usually at very high interest rates (called APRs) that typically range from 15–20%. Credit cards are provided by banks, but credit card companies, such as Visa and MasterCard, run the infrastructure and technology that makes credit cards work at millions of locations worldwide.
The Credit Card Trap
People often make the mistake of thinking that credit cards are a “good deal” because they allow you to spend money without having to pay right away or in full for the things you buy. With a credit card, you can charge up to your credit limit (the total amount of credit for which you’ve been approved) and then just make your minimum monthly payments. This arrangement is anything but a good deal—
failing to pay off your entire credit balance in full each month makes every item on your credit card bill cost much more, due to the sky-high interest rates you’ll be paying on your card’s balance. For instance, if you charge $1,000 to a credit card with an APR of 18% (a typical credit card APR) and make only the 2–3% minimum monthly payments, it would take roughly six years to pay off the balance and cost about $600 in interest charges.
How to Use Credit Cards Responsibly
You can avoid falling into the credit card trap by following two simple rules:
- If you use credit cards, pay off your balance in full each month.
- If you find yourself falling into the credit card trap by not paying off your balance in full each month, stop using credit cards entirely and use debit cards instead.
How to Get Out of Credit Card Debt
If you’ve run up a large credit card balance that you can’t pay off, first try to pay down your balances gradually by budgeting and cutting back your spending. If you can’t get out of credit card debt on your own, you do have a few options, such as debt consolidation, credit counseling, and in extreme cases, declaring bankruptcy. For more on how to get out of debt, see the Quamut guides to Getting Out of Debt and Personal Bankruptcy, available in Barnes & Noble bookstores and online at www.quamut.com.
Store-Issued Credit Cards
Many large retailers offer their own credit cards for use in their stores exclusively. Though these stores often run “rewards” programs associated with their cards, it’s generally best to avoid these cards, as their benefits usually pale in comparison to their annual fees. In addition, having numerous cards makes budgeting more complicated.
Home Equity Credit Cards
Home equity credit cards allow you to borrow against the equity you have in your home—the difference between your home’s market value and the principal that you still owe on the mortgage. These credit cards feature lower APRs than regular credit cards, and any interest you pay is generally tax-deductible. The main drawback is that you’re borrowing against the ownership stake you have in your home: if for some reason you can’t pay off your balance, in the worst-case scenario you could lose your home.
Charge Cards
Charge cards work like credit cards, but with one major difference: they require you to pay off your balance in full each month. If you can’t manage to pay off your balance, you’ll have to pay severe fines. Charge cards are often used by affluent consumers who have plenty of cash to pay off their monthly balances on time and in full and who want the additional services, such as travel and warranty protection, that charge cards often provide. It’s no surprise, then, that many charge cards also levy sizable annual fees. American Express is the most popular issuer of charge cards (though it also issues credit cards, such as its American Express Blue Card®).
Debit Cards
Debit cards look and feel just like credit cards, but they work like checks: when you pay for an item with a debit card, the money is debited (removed) from your checking account immediately and in full. Debit cards are a great alternative to credit cards for a few reasons:
- Convenience: You can use debit cards wherever MasterCard or Visa credit cards are accepted.
- Budgeting: Debit cards enable you to track your spending: if you use a debit card instead of cash or a check, your monthly statement will include a precise record of the date, amount, and type of each of your transactions.
- Accessibility: Generally, you’ll receive a debit card immediately upon opening a checking or savings account. You don’t need to apply or get approved for a debit card as you do with a credit card.
Two Warnings About Debit Cards
- Overdraft protection: Banks often offer debit cards with overdraft protection that allows you to spend more than the actual amount of cash in your account. Though overdraft protection is meant to prevent you from incurring bounced check fees, it can also tempt you to spend beyond your means. If you think you’ll be tempted to abuse overdraft protection, consider asking your bank to remove it from your account.
- Credit card features: Many debit cards convert to credit cards if you spend more than the amount of money you have in your checking account. You’ll then receive a standard credit card bill for whatever excess amount you’ve charged. Ask your bank whether your debit card includes this feature; if so, consider disabling it if it becomes a problem.
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