Every year, thousands of college graduates receive their diplomas - and plenty 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 a recent grad and have minimal experience with credit cards, here's a guide for how to use them to your financial advantage.
Credit cards are a form of revolving debt, which typically are open-ended accounts that don't have fixed monthly payments and come with a set credit limit established by the credit card issuer.
Some revolving debt arguably won't hurt you and can be a perfectly intelligent financial decision. For example, 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, a bunch of new clothes or a new iPad on your credit card, and you only make the minimum monthly payment, allow most of the debt to carry over to the next month and are charged compounding interest (meaning your interest starts earning interest), that's where you can get into serious financial trouble really quickly.
Before you start spending on a credit card, it's worthwhile to go to a credit card calculator and play around with the numbers to see what you could spend on interest if you only make the minimum payment. It's eye-opening.
"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. "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."
However, if used wisely, credit cards can help recent grads build or repair their credit, especially if they've made financial mistakes while in college.
"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."
However, Palmer isn't saying you should apply for multiple credit cards and go 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."
Trevor Shakiba, a certified financial planner and president of The Shakiba Group, a Houston, Texas-based financial advisory firm, adds that credit cards are most useful when they're used sparingly.
"Use it only for specific purchases, such as gas, which can paid off consistently each month at about the same amount," he advises. "This will help them [young people] build their credit while teaching key money management principles. It's best to treat it like a debit card. Only charge what you can presently pay off."
Understand How Credit Cards Affect Your Credit Score
Your credit history is what the credit reporting bureaus use to create your credit score. With every swipe of a credit card, you're taking an action that will impact your score.
Why is your credit score so important? Ranging from 300 to 850, this number represents how responsible you are with your credit. The higher your score, the better.
Ironically, if you've never used credit, 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.
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 away from credit cards completely may hinder you in the future.
Understand the Credit Card Terms
By now, you probably understand some of the benefits of credit cards. But just how do you go about getting one?
Dozens of companies offer cards that you can get after applying online, depending on your creditworthiness. However, before you select a card, review and compare the terms and conditions. You'll need to read the fine print to understand things like the APR, annual and foreign transaction fees and balance transfers. Here are few key terms you should know:
APR: It's critical to know the annual percentage rate, or APR, of any credit card you're considering. The APR determines how much interest you'll pay on your credit card debt if you carry a balance. You can gauge how much daily interest you'll accrue for carrying a balance by dividing the APR by 365. For example, if a credit card comes with a 13.99 percent APR, the daily periodic rate (or daily interest) would be around .038 percent.
Many credit cards come with a "teaser rate" to entice you to sign up for the card. For instance, you may be offered 0 interest for six or 12 months. It's important to know what that rate will be after the introductory period. If the APR jumps to 24 percent and you've got a $1,000 balance, that's suddenly going to cost you around $20 per month.
Annual Fee: An annual fee is the amount a credit card company charges you to use its credit card. It's charged once a year to your card. To attract new card members, some credit cards offer an introductory $0 annual fee for the first year, while others may not have a fee at all.
Foreign Transaction Fee: If you travel abroad during the year for work or pleasure, this is one fee you should be aware of. This fee, which typically is around 3 percent, is what a credit company charges a cardholder to use his or her card in a foreign country.
Balance Transfer: Balance transfer credit cards allow you to save on interest by moving an existing balance from a high interest rate credit card to one with a lower rate. This is a great option for recent grads who may have accrued credit card debt in college. If you have student loans (who doesn't today?), you know how interest can increase the amount you owe and extend the time it takes you to pay off the balance. Many balance transfer cards come with introductory offers such as 0 percent APR for 12 or 18 months, and some credit card companies even waive the 3-5 percent balance transfer fee they charge to transfer your debt. These cards only work to your advantage if you pay off the transferred balance in full before the end of the intro period.
In addition to these standard features, many credit cards offer rewards and perks. If you're new to credit cards, you may not realize just how much variation there is in credit card benefits and terms. However, this is important if you hope to do more than just build your credit history. Palmer says she likes credit cards because they give consumers the opportunity to stretch their dollars further.
If you have a job in which you travel a lot, Palmer says, you may want to look for an airline credit card that offers bonus points or miles as well as free traveling perks. If you plan to use the card for everyday spending, a rewards credit card that pays cash back for each purchase is a good option. 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 someday to be.
"You have to be aware of the terms, the interest rates, the fees and what not," says Carlson. "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."
Get a Starter Credit Card
Ideally, you should have started building your credit while still in school. Several companies, including Discover and Capital One, offer student credit cards that include features like an intro 0 percent APR and no annual or foreign transaction fees.
If you didn't take advantage of these cards while in school, you'll have to look elsewhere for a starter card that offers favorable terms and meets your needs. There are several options:
Prepaid Credit Cards: A prepaid credit card comes with balance limits that help guarantee you won't get in over your head financially with credit card debt. Just be aware that these cards typically come with several fees.
"Prepaid credit cards can be useful because they limit spending to the amount loaded onto the card," says Gail Cunningham, a vice president at Silver Springs, Maryland-based National Foundation for Credit Counseling, a consumer financial advocacy group. "Opt for safety and quality. Cards branded by Visa or MasterCard can be used anywhere that network is accepted, and thus are very convenient."
Secured Credit Cards: If you have bad credit, consider a secured credit card. With a secured card, you put down a deposit (usually a couple or few hundred bucks) and then use it like a regular credit card. The credit card is called secured because you have to put down a deposit or other collateral to get it. This minimizes the bank or credit card issuer's risk for letting you borrow. Local credit unions are a great place to start looking for a secured card as well as banks where you have an existing relationship. You should be able to find one with an annual fee of $39 or less. The terms can vary quite a bit, so be sure to shop around until you find one with the lowest fees and interest rate. If you use a secured credit card often enough and pay it off every month, you can improve your credit enough to transfer it to an unsecured credit card, which makes up the majority of the consumer credit market.
Become an Authorized User: If you're just starting out, ask your parents if they're comfortable adding you as an authorized user on their card. If they are, you can make purchases on their card and potentially benefit if they have a good credit history. The card will be in your name, but since you aren't a co-signer or joint account holder, you won't be liable for any charges or balances on the card. Just be sure to use the card responsibly. If you don't, this could damage the primary cardholder's credit - and your relationship. This is why these arrangements work best only with someone you trust.
Use Credit Responsibly
Because credit cards are revolving debt and readily accessible, it can be easy for borrowers to misuse them and damage their credit score. Don't make this mistake. Follow these tips from Anas Osman, vice president of acquisition at Discover Card, to build your credit, improve your credit score and use your card wisely:
Pay all of your bills on time each month. By paying on time, you're showing the lender or creditor that you've got enough cash flow to cover your expenses. If you pay late and the creditor reports your late payment to the credit bureaus, it may damage your credit history and lower your credit score.
If possible, pay off your charges in full at the end of the month. Use your credit as it was intended: as a short-term loan. Become familiar with the payment terms of your credit card. If a larger expense like a car repair or holiday travel requires that you carry a balance for a few months, set achievable goals to repay the debt as soon as your cash flow allows.
Keep total charges well within your credit limit. Start building your credit history by using a credit card with a low credit limit. This can help you learn to use cards in a more controlled setting.
Take advantage of the useful tools credit card issuers offer, including text and email alerts about upcoming due dates and automatic bill pay. This will ensure you don't miss a payment.
Contact the issuer if you're having trouble making a payment. There may be payment programs available that can help you get back on track.
Following this advice will set you on the right financial path and allow you to leverage credit cards in a way that strengthens your buying power. Just keep in mind that it's not free money - it's a tool to help you learn financial responsibility.