Credit Card Basics

By Kaitlyn Szabo • April 1, 2022

Credit cards are authorized lines of credit offered by banks or other financial institutions. By paying with a credit card (instead of with cash or a debit card), you are borrowing money from the credit card company to cover the purchase, and they will bill you later. Upon receipt of the bill, the expectation is that you will repay at least the minimum payment by the due date. Otherwise, you can pay the balance in full or an amount in between the two.

Here are several “need-to-know” terms related to credit cards:

• Annual Percentage Rate (APR) is the yearly interest rate charged on outstanding balances, including interest and fees. 
• Balance is the total amount of money you owe on your card account at any given time. 
  • Statement balance is the total charges at the end of your billing cycle. This includes any unpaid balance from previous cycles and accrued interest.
• Credit Limit is the maximum amount of money you can borrow using that particular credit card. 
• Minimum Payment is the amount you must pay each month by the due date to avoid late fees.

How a Credit Card Impacts Your Credit Score

As is the case with other products (like loans, for example), credit card usage can positively or negatively influence your credit score. The five major factors influencing a borrower’s credit score are

• Payment history: the percentage of all payments a borrower has made on time,
• Credit utilization: how much of a borrower’s available credit is in use (e.g. if your credit limit is $5,000 and your balance is $2,500, your credit utilization rate is 50%),
• Credit age: how long an account has been open,
• Variety of credit: the total mix of open and closed accounts,
• Credit inquiries: the total number of credit applications.

Generally speaking, your credit card usage will directly affect the first three of these factors, which are also the most impactful to the score itself. For example, paying at least the minimum payment on time each month, keeping your utilization below 30% of your credit limit, and leaving old accounts active and in good standing are all behaviors that typically positively impact your credit score. Alternatively, missing payments, maxing out your credit card(s), or applying for too many cards at once are habits that typically negatively affect your score.

Common Myths about Credit Cards

There are a lot of misconceptions about credit cards out there. Here are two myths that our team hears most often. 

• Firstly, many consumers believe that carrying a balance on your credit card can help your credit. In actuality, it may hurt your credit if your utilization is too high. 
• Secondly, some cardholders also think that canceling old cards will improve their credit. But again, closing an existing card might lower your score by increasing your utilization and decreasing your credit age.

So if carrying a balance or closing an old card could likely decrease your score (at least in the short term), when would it make sense to do either one? Using a credit card to pay for an emergency expense or large purchase over a few months may be the most cost-effective option (versus a high-interest payday loan, for example), so long as you have a plan to pay it off. On the flip side, if you find yourself maxing out credit cards or relying on them to live significantly above your means, closing the card can reduce the temptation and help you eliminate debt.

Additional Learning Materials and Resources

For more articles on credit in general and credit cards specifically, check out our previous blog posts on opening a credit card, reducing your credit card debt, improving your credit, and credit reports and credit scores. Our team also created the “Credit Score Game” as an interactive, engaging way to learn more about credit scores.

If you’re struggling with credit card debt, connect with LSS Financial Counseling to see if their services can help you.

Money Management E-Newsletter: March 2022