Understanding Credit

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Even if you can prove that you have the means to repay credit card debt, it is important for you to thoroughly understand how credit cards work and how they can both help and hurt you. Simply put, a credit card allows you to buy something now and pay for it later. Each month you will receive a statement listing all purchases you made using your credit card during the previous thirty days. The statement will request a payment toward your balance and will set a payment due date. Your payment options will vary: You can pay your entire balance, pay a specified amount of the balance, or pay only a minimum payment, which may be as low as $10.

YOUR TURN

Discuss

Discuss with a small group your use of credit or debit cards. Which (if either) do you have, and which do you prefer? Make a list of the advantages and disadvantages of each and share your list with the whole class.

But beware: If you make only a minimum payment, the remaining balance on your card will be charged a finance fee, or interest charge, causing your balance to increase before your next bill arrives even if you don’t make any more purchases. Paying the minimum payment is almost never a good strategy and can add years to your repayment time. In fact, if you continue to pay only $10 per month toward a $500 credit card balance, it will take you more than seven years to pay it off! Assuming an 18 percent interest rate, you’ll pay an extra $431 in interest, almost doubling the total amount you originally charged.

Avoid making late payments. Paying your bill even one day late can result in a finance charge of up to $30; it can also raise the interest rate not only on that card but also on any other credit accounts you have. If you decide to use a credit card to build credit, you might want to set up online, automatic payments to avoid incurring expensive late fees. Remember that the payment due date is the date that the payment should be received by the credit card lender, not the date that you send it.

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If you decide to apply for a credit card while you’re in college, remember that it should be used to build credit and for emergencies. Credit cards should not be used to fund a lifestyle that you cannot otherwise afford or to buy wants (see the section on budgeting earlier in this chapter). On the other hand, if you use your credit card just once a month and pay the balance as soon as the bill arrives, you will be on your way to a strong credit score in just a few years.

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In Case of Emergency It is a good practice to have a credit card for emergencies. What might warrant the use of credit is paying for critical expenses to care for yourself or your family, dealing with an auto accident, an unforeseen medical expense, or a last-minute need to travel to handle a crisis. Remember that spring break is not an emergency.

FREQUENTLY ASKED QUESTIONS ABOUT CREDIT CARDS

Here are some answers to common questions about credit cards:

  • I have a credit card with my name on it, but it is actually my parents’ account number. Is this card building credit for me? No. You are considered an authorized user on the account, but your parents are the primary account holders. To build credit you must be the primary account holder or at least a joint account holder.
  • I choose the “credit” option every time I use my debit card. Is this building credit for me? No. Using the credit function of your debit card is more like an electronic check because it is still taking money directly out of your checking account. Even if your debit card has a major credit card (Visa, MasterCard, etc.) logo on it, it is not building credit for you.
  • I have a few store credit cards (Target, Kohl’s, Best Buy, etc.). Are these accounts included on my credit report? Yes. Although they will affect your credit score, they do not carry as much weight as major credit cards (Visa, MasterCard, etc.). It is OK to have a few store credit cards, but a major credit card will do more to help you build credit.
  • Where can I apply for a major credit card? A good place to begin is your bank or credit union. To obtain a card, remember that you will have to prove your ability to make payments. Use your credit card to build credit by making small charges and paying them off each month.
  • If one credit card will help me build credit, will several build my credit even more? Research shows no benefit to having more than two major credit cards. Also, even if you’re able to pay the required monthly amounts, having too many accounts open can make you appear risky to the credit bureaus determining your credit score.
  • What if I forget and make a late payment? Is my credit score ruined? Your credit report reflects at least the past seven years of activity but puts the most emphasis on the most recent two years. In other words, the farther you get from your mistakes, the less effect they will have on your credit score. There is no quick fix for improving a credit score, so beware of advertisements that say otherwise.
  • If building credit is a wise decision, what’s so bad about using credit cards to buy some things that I really want but can’t really afford right now? It is not wise to use credit cards to purchase things that you cannot afford. Living within your means is always the way to go.
  • Where can I get my credit report? You can keep an eye on your credit report by visiting the free Web site www.annualcreditreport.com at least once a year.