Why a Credit Card is Not Just a Magical Piece of Plastic
Credit cards, much like debit cards, are *magical* pieces of plastic that are linked to your bank account and can be used to buy just about anything. Even more magical, you don’t actually need to have money in your bank account to buy things with a credit card. The not-so-magical catch is that you will need to pay off those purchases (AKA your balance, or credit card debt) eventually, usually in the same month as when the purchase was made, and failing to do so can have some serious consequences. This is because when you buy something with a credit card, you’re actually “borrowing” the bank’s money for the purchase, and promising to pay the bank back at a later date.
With a debit card, you can spend as much money as you have in your bank account. Generally, if you don’t have any money in your bank account, then your debit card will get denied. With a credit card, you can spend up to your “credit limit” - an amount the bank decides based on your current income, credit score, and other factors - regardless of the amount you’ve got in the bank. If you don’t make much (or any) money, or this is your first card, then your credit limit will probably be pretty small. My first card, when I was working a minimum-wage job part-time, had a limit of $700. The good news is that over time, this credit limit will slowly go up (sometimes even automatically, without you actively doing anything) as long as you’re always paying your card on time.
The (not so) bad news is that this credit limit is a mirage - if you can, you should never spend up to your credit limit.
A good rule of thumb is to never spend more than 30-40% of your limit before paying off your credit card balance (once you pay off your balance, your usage of the limit resets back to 0%).
So when my limit was $700, if I had spent about $300 on that card for the month, I would switch to using my debit card until I paid off that balance for the month. Then the next month I could start spending on the card again. This 40% rule is arbitrary. The idea is basically just to not hit your limit since that makes banks worried you’re too reliant on the credit. The other thing that will go up over time with the responsible use of a credit card is your credit score. Consistent usage of a card, and importantly paying off your balance, will result in a quickly rising credit score. Unfortunately, using your debit card does not have any effect on your credit score (and no, there’s no such thing as a debit score).
So what about credit card debt? This is the big danger you may have heard in regards to using a credit card, along with horror stories of huge interest payments that make it impossible to get out of debt. The danger comes from not paying your balance before your credit card bill is due, at a preset date each month (which your bank usually lets you choose for yourself). If you pay off your entire balance before the due date, then your credit score goes up and you don’t have to pay any interest. If you don’t, then things may get messy. High interest rates (up to 25% sometimes!) will make that debt grow very fast. To figure out the exact interest rate (often referred to as the “APR”) that would be charged, you may need to look into the contract or disclosure form of the card. Banks are required to share that information, and it’ll look something like this:
Just like any other debt or loan, it can be both an opportunity and a tremendous burden - it depends entirely on how you use it. Credit cards are as good as you make them be for yourself. This leads us to the next point...
