Since many of us might still be paying off our holiday spending, now is a good time to discuss credit cards and how they work. While credit cards can help us with emergency expenses, improved credit scores and more, we need to make sure not to overextend our budgets to the point where our credit card debt is burdensome.
Simply put, a credit card is a loan. You are borrowing money to make purchases, and that could include paying interest on top of the purchase price. The best way to use a credit card is to avoid accruing interest on your purchases. So, how do you do that?
All credit cards come with what is called a “grace period,” the period between the end of a billing cycle and the date your bill is due. The grace period is determined by the financial institution that issues your credit card. When it comes time to make your next payment, pay the full amount you charged within the grace period and you will avoid interest payments on the card. This is a good way to ensure you pay only the purchase price for an item and nothing extra.
To illustrate the cost of making only the minimum payment on a credit card, let’s say you charged $500 on your credit card. When the bill arrives, you decide to only pay the minimum payment of $15 and the card has an interest rate of 8.9 percent (average credit card interest rates currently range from 13.24 percent to 22.99 percent APR). If you continue paying down the balance by only making the minimum payment every month, it will take you more than three years to pay off what you charged and you’ll pay an additional $76.49 in interest.
Using credit cards responsibly
The best way to use a credit card is to be aware of how much you are borrowing and to make sure you have the ability to pay off the balance sooner rather than later. Even if you can’t afford the full amount you charged when the bill arrives, try to pay more than the minimum to lessen the time it takes to pay down the debt and reduce the amount of interest owed. Using the example above: if you double the payment to $30, you will cut your total interest payment to $35.70 and pay off the debt in a year and a half instead.
Affect to credit scores
Credit cards can be an easy way to build credit history and improve your credit score if used responsibly. The two big factors lenders consider with credit cards are usage and the ability to pay. The best way you can keep those factors positive is by charging something you can pay for every month — think about automating the payment of your least expensive bill—and pay off your entire bill without leaving a balance on your card. If you do this every month, you will see your credit score improve over time.
Credit cards don’t have to be a burden. Make sure you know exactly how they work before you use one. That way, you’ll be able to reap the rewards without creating any financial stress for yourself.