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Used wisely, a credit card can protect your finances, help you earn rewards and build your credit. Used unwisely, a credit card can be a way to accumulate high-interest debt quickly. So what should you know before you open your first credit card? We’ve compiled a list of five tips that will help you get off to a good start on your credit journey.
In this article:
- Why getting credit is a smart move
- Credit card terms you need to know
- What to look for in a first credit card
- Mistakes to avoid with your first credit card
- The bottom line
Why getting a credit card is a smart move
Responsible credit card use is an easy way to build your credit score, which will positively impact your financial future. Your credit history will affect the interest rates you can get on auto loans and mortgages. It can also impact what type of premiums you’ll pay for car insurance and whether or not rental companies will approve you for an apartment. It can even affect your chances of getting a job if a potential employer requests to check your credit before making an offer.
“Using a credit card is like driving a car — you need to be aware of what can go wrong,” said Sally Herigstad, a retired CPA and personal finance expert. “But then you need to learn how to use it responsibly and trust yourself to do so.”
Credit cards also offer a layer of security for your finances. Under federal law, you’re not responsible for more than $50 if your credit card is used for a fraudulent transaction — and many credit card companies will go beyond that, offering zero liability protection so that you aren’t liable for fraudulent charges made with your card. Contrast that with debit cards, which offer less protection, and cash, which offers virtually no protection.
Not only that, credit cards come with dispute protections as well. So, if you purchase an item that is damaged or you receive substandard service and can’t work things out with the company or person who provided the product or service, your credit card company will work on your behalf to get a charge refunded.
Credit card terms you need to know
Credit limit. Your credit limit is the maximum debt you can carry on your card at one time. For example, if you have a $1,500 credit limit, you may not be able to charge more than $1,500 in purchases to the card before paying some of the debt off. However, you should never use more than 30% of your credit limit — see the section on how your credit score works for details.
APR. This means “annual percentage rate.” It’s the interest rate on your credit card and will be applied each month to any balance that is not paid off by the due date. It’s important to note that when you see an APR range listed on a card application, there’s no way to know where your interest rate will fall until you’re approved for the card. A higher credit score means more chances of getting a better APR, but it’s not a guarantee.
Balance. If you pay off everything you charge to your card within the same billing cycle, you won’t be carrying a balance. But if you make only the minimum payment due, or make more than the minimum but less than the full amount, you’ll be carrying a balance. The balance is what accrues interest. This is how credit card companies make money.
Minimum payment due. During each billing cycle in which you’ve made purchases with your card, you’ll have to pay at least a certain amount — that’s the minimum payment. Minimum payments are generally calculated to include all fees and interest due plus 1% of the principal owed. When you only make the minimum payment, very little goes toward paying down the principal debt, which is why it’s always wise to either pay more than the minimum payment due or the entire balance.
Annual fee. Some cards charge an annual fee, which is typically assessed during the first billing cycle. The annual fee is charged whether you use the card or not. Some cards offer enough in rewards and perks that, depending on your spending habits, you can recoup the amount of the fee and even more. However, for your first credit card, it’s probably wise to avoid cards with annual fees.
Foreign transaction fee. If you make a purchase while traveling abroad and your credit card company charges extra — often around 3% of the purchase — that’s a foreign transaction fee. Know that not all cards charge this fee, so if you’ll be using a card overseas, apply for one that doesn’t assess this fee.
Hard inquiry. When you apply for a credit card, as well as other credit accounts such as a loan, the bank or card issuer will pull your credit report from at least one of the three credit bureaus — Equifax, Experian, and TransUnion. Whichever bureau your report was pulled from will now show that inquiry for the next two years. If you have too many hard inquiries, issuers are likely to see you as a risk. A hard inquiry temporarily decreases your credit score by 5-10 points, but will bounce back after a year.
Soft inquiry. A soft inquiry, unlike a hard inquiry, does not show up on your credit report or decrease your credit score. Soft inquiries happen when you check your own credit report or when a lender reviews your credit file for potential marketing purposes.
Secured card. A secured credit card requires you to put down a deposit, which usually becomes your credit limit. In all other respects, a secured card should function the same way as a regular, unsecured card. You still have to make payments on what you charge — the deposit doesn’t cover that. Secured cards can be easier to qualify for people with bad credit or with limited credit history, and some card issuers will upgrade customers to an unsecured card after a certain period of responsible card use and may refund the deposit.
Authorized user. If someone adds you as an authorized user to their credit card, you will get a card for their account. Many credit card issuers, but not all, will report credit card usage on authorized users’ credit reports. This can be a good thing for building your history and score if you’ve been added to a card by someone with good credit behavior, but a bad thing if the main cardholder has a history of late payments or of carrying high balances.
An authorized user is different from a joint account holder. Whereas both account holders are responsible for paying back what’s charged to a card, in the case of an authorized user, only the main cardholder is legally responsible. However, you should still make a point to practice good credit behavior as an authorized user. After building up good credit history as an authorized user, you’re more likely able to qualify for a credit card when applying on your own.
How your credit score works
One of the most commonly used credit scoring models is FICO. There are five factors that comprise your FICO score:
- Payment history. This comprises 35% of your score. The most important habit to adopt when using credit cards to ensure a good credit score is to always pay your credit card bill on time.
- Amounts owed. This is 30% of your score, and is often referred as credit utilization. Keep your utilization ratio low — for example, if your credit limit is $1,000, never have more than $300 in debt on the card.
- Length of credit history. How long you’ve been using credit comprises 15% of your score.
- Credit mix. Managing multiple types of credit (credit cards, loans) comprises 10% of your score.
- New credit. This is 10% of your score. It reflects how often you apply for and open new accounts.
What to look for in a first credit card
Some credit cards require an excellent credit history and won’t approve applicants with no credit or limited credit. So when you’re looking for your first credit card, one of the things at the top of your list should be a card issuer friendly to applicants who are new to credit.
You also want to make sure you’re applying for a card from a reputable company with good practices and that doesn’t charge a lot of fees. Familiarize yourself with a card’s terms and fees before applying.
When new to credit, don’t be surprised if you get a low credit limit to start out. You might qualify for a credit limit increase after demonstrating responsible behavior over your first year of having the card. (Just make sure to actually use the card — you want on-time payments and other good behavior to be reported to the credit bureaus.)
Two credit card companies that are often good choices for those starting out are Discover and Capital One. For specific recommendations, check out our list of best cards for beginners.
There’s also the Petal® Visa® Credit Card, specifically designed for applicants with limited credit history. Rather than pulling a credit score for your application, the Petal® Visa® Credit Card will run an algorithm that looks at other factors to determine your financial health.
If you’re a college student, you may consider applying for a student card. Some, such as the Discover it® Student Cash Back, offers a Good Grades Rewards: $20 statement credit each school year your GPA is 3.0 or higher for up to the next 5 years. For new cardmembers, Unlimited Cashback Match – only from Discover. Discover will automatically match all the cash back you’ve earned at the end of your first year! There’s no minimum spending or maximum rewards. Just a dollar-for-dollar match. .
After you get approved for your first credit card, focus on demonstrating responsible usage. Pay on time and in full, keep your utilization low, and keep an eye on your credit score.
Mistakes to avoid with your first credit card
Spending too much. Remember to keep your utilization under 30% of your credit limit. The closer you get to maxing out your credit limit, the more damage you will cause to your credit score.
“Payment history is the most important thing, but credit utilization is right behind it,” said Stephen Newland, an accredited financial counselor and owner of Find Your Money Path. “The FICO scoring system looks at that and says, if you’re consistently using [a high amount such as] 80% of your extended debt, that tells us you’re a higher risk because you can’t manage this well.”
Making only the minimum payment. You should aim to pay off your card in full and on time each billing cycle. If you can’t, it’s still smart to pay as much as you reasonably can. When you make only the minimum payment, you aren’t actually doing much to pay off your card debt. It’s best to stop adding to your balance until you get it under control.
Applying for multiple credit cards. After you get your first card, your next step should be to settle in, use the card responsibly and allow your credit score to reflect your good behavior. It may be tempting to try to get more cards, but having multiple hard inquiries on your credit report in a short period of time can actually cause your credit score to drop.
The bottom line
A credit card can be a good tool to protect your finances and build credit history. Just be smart in what you choose to apply for, and be responsible in how you use your card once you get one.
“Except in an emergency, like being stranded in a snowstorm, don’t use your credit card for anything you can’t afford to pay cash for,” Herigstad said. “If you don’t have the money in your bank account to buy something, you can’t afford it. Next month’s paycheck never goes as far as you think it will. Credit cards are excellent payment tools, but they are lousy long-term loans.”
Once you’ve had your first card for a while and have shown good behavior, you may be able to qualify for cards aimed at those with excellent credit. These are likely to offer rewards such as cash back and miles, and may come with attractive sign-up bonuses and additional perks.