The Basics of Credit Cards and Credit Card Debt

Updated January 28, 2022

Credit cards are an important component of building a strong credit history. Your credit history impacts your ability to take out loans for things like buying your first home, and it can lead to improved rates. Your credit history is also essential for other things, like renting an apartment or opening a cell phone plan. Credit cards — if used properly — can be effective in helping you to create a credit history in order to reach your financial goals, including becoming a homeowner.

According to Magnify Money, Americans paid banks $121 billion in credit card interest in 2019, up 7% from the $113 billion in interest paid in 2018. Because of this rising category of debt, it is important that you understand the basics of credit cards, how they are meant to be used, and a few tips on how you can get the most out of having them – without falling into debt.

What is a Credit Card?

A credit card looks just like a debit card, but instead of taking money out of your account when you make a purchase, it borrows money from your bank. Most credit institutions will give users a twenty-five to thirty day grace period with which to pay back the money they borrowed. If you do not pay the amount back within the allotted time, the bank will add interest to the remaining balance. The amount of interest added will be determined by your credit card’s interest rate and the amount of money that you owe for the remainder of the grace period.

Have a Repayment Plan

Users must be careful when making purchases with a credit card. It can be tempting to make a large purchase with a credit card and push the payment off until later. Forbes magazine says, “Credit cards are like DVRs for money,” because like a DVR, a credit card allows you to pay now, and then pay it back later. This philosophy is what can lead to bad spending habits. So make sure that you have a plan before you make a purchase on your credit card. Look at your budget, and make sure that you allocate money for the use of paying off your credit card. Credit cards should be used as an extension of your financial accounts, NOT as a supplementary form of income. Making sure that you don’t spend more on your credit cards than you can pay back will ensure that you won’t find yourself in financial trouble.

Recommended Usage

Having a credit card is a great way to boost your credit and establish a good credit history. However, if misused, it can have a negative impact on your credit score. In the financial industry, there are various opinions about how to best use a credit card. What experts can agree on, however, is that there are several important things you can do to ensure that you stay in good standing with your credit provider.

1. The first things are to make sure that you never miss a payment. Whether you are paying a large lump sum or making a minimum payment — the minimum you can pay to stay in good standing — you must make sure to always pay on time. A missed payment could result in a reduced credit score.
2. Another great practice is to keep your balance at or below 35 percent of your credit limit. This is the optimal amount for a healthy credit score, says Lucy Duni of Truecredit.com.

Owning and using a credit card does not have to be a bad thing, and it certainly does not mean that you are going to develop bad spending habits. If you follow these suggestions and make wise purchases, your credit history will be strong, and you will reap the rewards of being in good financial standing.