What is a credit card?

Credit cards are both amazing and terrifying.

They allow us to pay for whatever we need instantly and without carrying cash around, and they take up only a tiny space in our wallets. A good credit card can be a powerful tool, but it can also be dangerous. Let’s take a look at what credit cards are and how they work.

Spending:

When you use a credit card to buy something, like those shoes you really, really want, you’re actually borrowing that money from the bank or credit card company. The company pays the store or vendor and you walk away with some shiny new kicks…and in debt.

Because you just borrowed money from the bank or credit card company, you now owe it that money. If you’re smart, you’ll pay back all of that money at the end of the month because then you don’t need to pay anything more than the price of the shoes.

However, if you don’t pay all the money back, you’ll be charged interest on it. This is something you want to avoid like the plague. Credit card interest is some of the highest interest out there. It’s not unusual to see 15% or more. Actually calculating this interest is complicated, but NerdWallet has a great article breaking down how credit card interest is calculated.

Limits:

Most credit cards have limits of how much you can borrow on them at one time. For teens and young adults, this number is usually in the low thousands. This number usually increases as time goes by and you handle the card responsibly. Of course, just because you have the ability to charge thousands of dollars doesn’t mean you should!

Ideally, you will never charge more than you can pay off at the end of the month. Otherwise, anything you don’t pay off will roll over to the next month and become credit card debt. (Boo, hiss!)

PIN:

In the United States, credit cards don’t require PINs. In many other countries, however, PINs, along with chips embedded in the card, are required to make purchases with credit cards. The chips are being adopted in the US, but are still paired with a signature rather than a PIN.

Security:

If your credit card is lost or stolen, you can contact your bank to stop further charges on it. Most credit card companies are very good about refunding fraudulent charges on your card and quickly sending you a new card. The biggest hassle involved with a stolen or lost card is having to change all online accounts that use that card. For the added security, however, all your online shopping/accounts should be attached to credit cards, rather than debit cards.

Credit History:

Credit card payments form the bulk of most people’s credit history when they are young. Before you have responsibilities like car payments and mortgages, credit cards and student loans are the best ways to prove how trustworthy you are with money and start building a credit score.

Responsible managing of a credit card or two over the long term is a great way to start building a good credit history. However, you have to be 18 to have a credit card in your name. If you’re too young to have your own card, there are other steps you can take to make a start building credit, which we’ll discuss in another post.

Fees:

Some credit cards charge a yearly fee to keep them. These ones often have great perks, but not always. Your first card should probably be a simple, no-fee card.

Perks:

The perks you can get from credit cards vary dramatically from card to card, but the most common ones are cash back and airline miles or points. Cash back simply gives you back a certain percent of your purchases on the card. Airline miles or points build up when you buy stuff on the card, and then you can use them to book airline travel for cheap or even for free.

When should you use a credit card?

Almost anything can be purchased using a credit card, which is why they can be so dangerous. It’s so easy to swipe that plastic and forget that the money isn’t free. However, with responsible use, credit cards are so much better than debit in many ways.

The perks, the security, and the credit-building power of credit cards makes them preferable to debit cards, but ONLY if you can trust yourself to not go on spending sprees. Of course, do your homework on any card you think you might want to decide which ones fit your needs and habits.

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