Revolving Credit Basics

Revolving credit is different from an installment loan (such as a car or student loan) because it doesn’t have a fixed number of payments or a final due date. The account revolves, or stays open indefinitely, as long as you make minimum monthly payments. The lender approves a maximum loan amount, or credit limit, to use at any time. Credit cards, retail store credit cards, and home equity lines of credit (HELOCs) are common types of revolving credit.

Applying for a Credit Card

If you’re under age 21, you must show that you have income or an eligible cosigner to qualify for a credit card. The law requires that you receive a Federal Truth in Lending Disclosure Statement from any company that offers you credit. Be sure to read it carefully so you understand the terms and can compare cards based on these features:

Managing a Credit Card

A credit card gives you the ability to make purchases now and pay for them later. For example, if you have a credit card with a $1,000 credit limit, you can use it to buy products or services, or take cash advances that total up to $1,000. However, you should never max out a credit card because that hurts your credit.

This flexibility makes credit cards powerful financial tools that can help you in an emergency situation. But credit cards can also devastate your finances if you get over your head in debt that you can’t repay.

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Because they’re so convenient for consumers and come with unsecured risk for lenders, credit cards charge relatively high interest rates that can exceed 30%. Every time you make a credit card purchase, you’re borrowing money that must be paid back. You’ll also have to pay interest charges if you don’t pay off your balance in full by the monthly statement due date.

Paying Your Credit Card

Credit cards issue an account statement each month that lists transactions from the previous month. The lowest amount you can pay—your “minimum payment”—varies depending on the card, but may range from 2% to 4% of your outstanding balance. For instance, if you owe $500, your minimum payment could be 3%, or $15. The remaining balance of $485 will continue to accrue interest, in addition to any new transactions you make or late fees that may apply.

However, if you pay off your entire credit card balance by the due date on your statement each month, you can use a credit card without paying any interest charges or late fees. That’s because no interest charges accrue during this “grace period.”

Tips to Reduce the Cost of Borrowing

The cost of borrowing money depends on several factors, such as the current interest rates, your credit rating, the APR you’re offered, loan fees, and how long it takes you to repay the debt. Here are 10 tips to reduce the cost of borrowing:

  1. Shop around for the lowest APR for a loan or credit card before you accept an offer.

  2. Finance an item based on the total price (including interest) that you can afford—not just on a monthly payment amount.

  3. Repay loans over a shorter term so you pay less total interest over the life of a loan.

  4. Pay off credit card purchases in full each month so you’re never charged interest or late fees.

  5. Make payments on time so you’re never penalized with expensive late fees or an increased APR on a credit card.

  6. Build a good credit history so you have high credit scores and will be offered low interest rates by lenders and credit card companies. Establishing credit was covered in Part 5 of this handbook.

  7. Make a bigger down payment so you’ll owe less and receive lower APR offers from auto and home lenders.

  8. Take out federal student loans before accepting private education loans so you qualify for the most favorable interest rates and repayment terms.

  9. Claim tax benefits that come with education loans, such as the student loan interest tax deduction, which may allow you to reduce the amount of tax you owe.

  10. Never take a payday loan, which is a short-term unsecured advance against your next paycheck. The interest rate for one of these loans can be over 15% for just two weeks—which translates into a sky-high APR that can exceed 400%!