The college grad's guide to credit cards
Every year around this time, thousands of college graduates receive their diplomas, maybe a slice of graduation cake, and an abundance of advice about making it in the real world. Credit cards are a powerful financial tool that can open doors when used wisely. If you're considering applying for your first credit card, these five tips can help you separate fact from myth and get the most out of your new credit card without getting into a financial tangle.
Don't shy away from credit cards
"Credit cards have been demonized a lot, to the point where a lot of college graduates think they should use other ways to spend their money, like only using debit cards. I think that's a bad idea," says Kimberly Palmer, senior editor and personal finance columnist for US News & World Report and author of the book Generation Earn: The Young Professional's Guide to Spending, Investing, and Giving Back.
That isn't to say Palmer believes you should apply for 10 cards and go for broke. "I'm not saying you should carry credit card debt. You should pay it off every month," Palmer says. "But credit cards can be very useful for building your credit history."
Your credit history is what the credit reporting bureaus use to create your credit score. Your credit score is a number between 300 and 850 that represents how responsible you are with your credit and how long you've been that way. The higher your score, the better.
And if you have a strong credit history and a high credit score, you'll get a much better loan rate when you buy a house or a car. Fear of going into deep debt is understandable. But staying out of credit won't help you in the future.
Ironically, if you have never, ever used credit cards, your credit history isn't spotless - it simply doesn't exist. When you try to buy a home or vehicle, lenders won't know if you are a good credit risk. You may find it harder to get approved for the amount you need, and you could end up paying a higher interest rate than if you had a history of using credit cards responsibly.
Understand the risks of revolving debt
Revolving credit is an open line of credit that you can charge things to each month up to the limit set by the credit card issuer.
Some revolving debt arguably won't hurt you and can be a perfectly intelligent financial decision. It's legitimate to use a business credit card to help fund a startup that has a solid business plan and can be reasonably expected to make money. If your car breaks down while you're on a road trip and you suddenly have an $800 car repair bill, it makes sense to use your credit card to get moving again if you have enough cash saved in your emergency fund to pay it off when you get home.
But when you put a pizza on your credit card, along with a bunch of new clothes, and a new iPad, and a trip to the movies, and the birthday gift for your cousin, and you only make a token monthly payment and allow most of the debt to carry over to the next month, and the next month, and your interest begins compounding (meaning your interest starts earning interest) - that's where you can get into trouble fast.
Before you start spending on a credit card, it's worthwhile to go to a credit card calculator, and play around with the numbers and see what you could spend on interest if you only make the minimum payment. It's eye-opening.
Know your credit card agreement
"Credit is extremely valuable, and it's really important to treat it with respect," says Lori Mackey, founder of Prosperity4Kids, Inc., a company that specializes in educating young people on credit cards (primarily kids who are a few years away from starting college).
"I think the most important thing for young adults to know is what it is that they're signing for. If they mess up their credit," Mackey says, "everything is going to cost more. It also could jeopardize their getting a job, because some employers look at your credit history, and it could mean you can't buy a home or a car. You may not even be able to rent."
Know your annual percentage rate, or APR. This determines how much interest you'll pay on your credit card debt if you carry a balance.
Many credit cards come with a "teaser rate" to entice you to sign up for the card. For instance, you may be offered zero interest for six months. It's important to know what that rate will be after six months. If the APR jumps to 24 percent, and you've got a $1,000 balance, that's suddenly going to cost you $20 per month.
Learn how your credit card works
Your credit score loves it when you pay on time. If you're going to be making payments at the last minute (not a good idea), you need to be aware of quirks. For example, the due date on all credit cards means you have until 5 p.m. that day to make your payment (exactly which time zone is up to the issuer). The easiest way to make sure payments are made on time is to set up automatic payments through your online bank or the card issuer's website. Or set an email alert to remind you several days ahead of time.
Knowing little details like that can make the difference between being a responsible credit card owner who makes good use of a credit card, and a credit junkie who ends up nickel-and-diming themselves into the poorhouse.
Compare credit cards to find the best one for you
If you're new to credit cards, you may not realize just how much variation there is in credit card terms and perks. This is an important point if you hope to do more than just build your credit history. Palmer says that she likes credit cards for the opportunities they can offer consumers to stretch their dollars further.
For example, Palmer continues, if you have a job in which you're traveling a lot, you may want to look for an airline credit card that offers bonus points or miles as well as free traveling perks. If you're going to be using your card for everyday spending, you might look for a rewards credit card that pays cash back for each purchase. Or you may just want a no-frills card with the lowest APR you can find.
"Don't just be satisfied with any offer that drifts into your mailbox," warns Karen Carlson, a financial literacy developer at InCharge Debt Solutions, which offers debt management and credit counseling to consumers who find themselves in over their head--in other words, the type of credit card user you don't want to someday be.
"You have to be aware of the terms, the interest rates, the fees and whatnot," says Carlson, a recent college graduate herself. "There is a tremendous choice of cards out there. You really have to comparison shop for a credit card the same way you would a computer or a cell phone."
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