A Glossary and a Guide to that First Credit Card
If you’re looking for that first credit card, you may need some help. Without the proper context, all that finance jargon can be intimidating. You might wonder what an APR is, or how interest works. If you’re a credit card newbie, check out the following glossary—you gotta learn sometime.
Here’s what you need to know before you make any decision about credit:
Budget: Know how much you’ll spend each month on utility bills, gas, food—the works. Without your budget, it’s impossible to make an informed decision about your spending. “Budgeting may not sound exciting, but it is the No. 1, sure-fire way to avoid credit card debt,” said Kevin Gallegos, VP of Phoenix operations for Freedom Financial Network. Gallegos advises that young consumers also “learn the difference between needs and wants. Many young adults find it too easy to get caught up in the wave of consumerism, and get used to living beyond their means. The meaning of ‘need’ vs. ‘want’ became lost in the years where credit was too widely available. Learn the difference between these, and live within your means – however large or small it is.”
Credit score: When a lender tries to decide if they’ll approve you for credit, they want to know if they can depend on you to make a payment—if you’re credible. Hence the term “credit score.” You can get your score for free by going to TransUnion or GoFreeCredit.com, signing up for their credit reporting service, and cancelling during the 7-day trial period.
Rewards rate: Your rewards rate is how much you earn back on every dollar you spend: free money. You may not be eligible for rewards, though, if you have no credit.
Annual fee: This one’s obvious. It’s a fee you need to pay every year to keep the card, although most student and plain-vanilla cards don’t have them.
Signup bonus: You’ll earn a statement credit, miles, points—whatever it’s called, it’s free money. Sort of. You often need to spend a given amount in a given period to earn the signup bonus.
APR: This one’s more complicated. The APR, or annual percentage rate, determines how much interest you pay every year. You often won’t know your exact rate until you’re approved, though: many cards charge a range of rates, so people with good credit scores end up with a low APR and the people with bad credit end up with a high APR. Although APR refers to the yearly rate, the interest accrues every day you carry a balance. If you have an APR of 20%, that doesn’t mean you’re charged 20% in interest every day. It means that, every day you carry the balance, you’re charged the following: 1 day / 365 days * 20% APR * balance.
Purchase APR: You thought you were done with APR! Almost. There are two kinds of APR you need to know: purchase and balance transfer. The former is easy; it’s the interest rate on new purchases that you make with the card.
Balance transfer APR: If you have debt from previous credit cards, you can move it to another account with a balance transfer. This transaction consolidates all that debt and therefore allows you to pay it off under a single card and a single interest rate—hopefully a lower rate than before. The balance transfer APR, then, is the rate your lender charges on all that debt. Some cards give you an introductory period of 0% balance transfer APR. You’ll still have to pay a balance transfer fee, so you’ll have to weigh the fee against your interest savings.
Got all that down? You’re almost ready to go. Before you apply for a card, you need to keep a couple things in mind.
Get the best deal with the help of a simple formula
We know that annual fees are off-putting. No one wants to spend money every year simply to be able to spend period. But the annual fee may be worth the pain if you can get the right rewards card. It’s a question of math.
The following formula can help out:
Your card’s value = Rewards rate * Spending – Annual fee – Interest Payments + (Signup Bonus)/Number of years you’ll have the card
Keep in mind that if you carry a balance – that is, you have to pay interest – you’ll often end up with a negative number. You’re better off with a low APR credit card if you don’t pay off your bills every month.
We’ve already cleared up the rewards rate, annual fee and signup bonus. Your rewards spending isn’t too hard to figure out, either. A rewards card can often give bonus rewards on certain categories, such as dining out, gas or travel.
Figuring out those categories may take some fine-tuning, so you may want to put off applying for the right rewards card until you’ve revised your budget. “Once you understand how much you can spend each month, I recommend getting a rewards card, and ONLY spending what you would have spent anyway, according to that budget,” said Meg Favreau, senior editor of WiseBread.com, a personal finance and frugal living website. “That way you can pay off your card every month while earning rewards like airline miles or cash back.
Work those rewards categories into your budget, and you’ll know how much you spend on each and therefore how much you stand to get back with rewards.
Interest is a bit harder to predict. As we explained above, interest compounds every day you carry a balance. Let’s say, then, that you pay your bill in full on day 5 of the billing cycle. Your interest will look like this:
Interest = (5 days/month * 12 months) / 365 days * APR * Average balance each month
If you expect you’ll pay later in the billing cycle each month, adjust the formula accordingly.
What kind of credit card should I get?
Have you had a credit card before? Even if your parents paid the bill, it matters if you did. Because if you co-signed—if both your names were on the account—then creditors have collected information about you and your borrowing habits. You’ll have a credit score, and if it’s a good score, then you could be eligible for some of the best cards out there. Remember, though, that you need an income to qualify for a credit card on your own.
If you haven’t hard a card before, and you’ve never had credit of any sort before—no, debit cards do not count—then you probably don’t have a score. The best option here is to get someone (like a parent) with an income and credit history to cosign the credit card for you, basically guaranteeing your debts. If cosigning isn’t an option for you, secured credit cards, which are specifically for bad-credit or no-credit consumers.