I was reading through some personal finance forums over the weekend, and I realized something pretty important.
Some people don’t know what it means to use a credit card.
Now, like with everything else, there’s no shame in not knowing, but you definitely need to know what you’re doing when you use a credit card.
So you’ve been using your debit card for years, but you see a cool new credit card out there that comes with rewards just for spending money. Maybe it’s cash back, maybe it’s airline miles, maybe it’s credits at your favorite store. Whatever the incentive may be, you decide to sign up.
Great! Awesome! You just took the first step in building your credit. But how do you use the card?
Well, just like you used your debit card. When you go to pay, you hand over your card instead of cash. But what does that really mean? It means the credit card company is essentially loaning you the money to pay for what you just bought. It also means that you have to pay the credit card company back.
When you get your statement for the card, you will see two main options of how much you can pay. You can pay the statement balance – the entire amount that you borrowed for that billing cycle (usually about a month). Or you can pay the minimum balance due.
This weekend, I learned that a lot of people don’t realize that they should probably pay more than just the minimum balance due.
You see, if you pay off the statement balance, you’ve basically just gotten an interest-free short term loan. You are paying the company no more money than you spent. And if it’s a rewards card – sweet! You just got something for nothing. (For the most part – some people will disagree, but I love rewards cards.)
But if you only pay the minimum balance, on your next statement, you’re going to see an interest charge. The credit card company isn’t going to let you use their money for free for long. You have to start paying for that privilege in the form of interest. How much interest will you pay? Depends on how much you spend and what the interest rate is on your card. And the bad news is that the cards with the best perks tend to have the highest interest rates. Makes sense – how else are they going to pay those benefits?
So you should make a point to pay off your full statement balance each month. That doesn’t mean that as soon as you make a purchase on your credit card that you have to run home and use the internet to transfer funds from your bank to your credit card. You will get a statement every month, either in the mail or online. Pay your statement balance. On my statement, it’s listed as the “New Balance.”
Credit cards can be a great tool if you use them responsibly. And that means never charging more than you can pay and always paying off your full statement balance each month. Then you can bask in the rewards that come your way (and the benefits to your FICO score too).