Look before you leap into credit cards
Building a good credit history while you’re in college gives you a big advantage when you graduate. For starters, you’ll have an easier time renting an apartment.
You might even dazzle prospective employers who decide to look over your credit report. Visual proof that you can handle credit responsibly is very appealing to an employer.
But getting a credit card is a lot of responsibility. So, before you even fill out an application, ask these 10 questions. If you’re comfortable with the answers, then go ahead and apply for your first credit card.
Let’s get started. The first question is about you.
(By the way, if you are still trying to decide where to go to college, don’t forget to check out U.S. News’ 2019 Best Colleges rankings.)
1. Have I ever overdrawn my checking account?
You might be wondering why I’m starting with this question, since we’re talking about credit cards. Well, if you have a checking account, the way you’ve handled that offers insight into your readiness for a credit card.
But don’t worry. If you answer yes to this question, that doesn’t mean you shouldn’t get a credit card. I want to know how you responded to the situation. Did you make things right as soon as possible? Has it happened more than once?
You might have overdraft protection on your checking account. If you do, have you ever paid the fee to have the funds transferred to your checking account to cover your expenses? If it’s happened multiple times, then you might want to wait a bit before getting a credit card.
But if this was an isolated event and a wake-up call to manage your money better, then keep going. You might be ready for a credit card.
2. What is an APR?
Credit card interest rates are expressed as an annual rate, referred to as the annual percentage rate. The APR includes the actual yearly cost of borrowing money with the credit card.
If you pay your balance in full and by the due date, you don’t have to worry about this rate. But if you do carry a balance, then your purchase APR determines how much interest you pay. It’s compound interest (explained in more detail in Question No. 6), and that makes your balance grow faster than you’d ever expect.
Your purchase APR is listed prominently where the rates and fees are shown on your credit card agreement, but there are other APRs, too, that are in smaller print.
3. Why are there so many APRs for one credit card?
Aside from your purchase APR, you’ll also see a different APR for cash advances, balance transfers and penalty rates. If you use your credit card to withdraw funds from an ATM, for example, that’s a cash advance. This is usually higher than the purchase APR.
Often, credit cards offer a zero percent introductory APR for balance transfers (and sometimes on purchases, too). The introductory offer is for a set period, such as 12 to 21 months. When the intro period ends, your rate will go up — sometimes, way up — to whatever your new purchase APR will be. That’s when compound interest begins accruing on any balance remaining in your account.
Penalty APRs aren’t as common as they used to be, but they still exist and they can go up to around 30 percent. This rate kicks in if certain conditions are present, such as being more than 60 days late with your payment.
4. Is it OK to get a cash advance with my credit card?
In Question No. 3, I mentioned the example of getting a cash advance with your credit card from an ATM. Let’s see how the process plays out.
If you withdraw $1,000 using your card, it shows up on your account as money you owe the issuer. In theory, it seems like a quick way to borrow money. But in reality, it will cost you a bunch. The interest on your $1,000 withdrawal starts as soon as it’s posted to your account.
When you make purchases, your credit card has a grace period, which is the time between when your purchase is made and the due date on your monthly statement. The grace period is usually about 21 to 25 days.
But with a cash advance, there’s no grace period.
So, you’d be borrowing $1,000 with an APR of around 25 percent or more in some cases, with the interest clock starting immediately. Plus, there’s also a transaction fee that’s usually 3 to 5 percent of the total advance. In this example, the fee could be as high as $50.
A cash advance is almost never a good idea. Getting a cash advance is something that should only be done in an emergency. And even then, think twice about it.
5. What kind of fees do credit cards have?
The fees and their amounts vary by issuer. Here are some of the more common fees:
— Annual fee: This is the yearly fee for using the card. The credit cards most likely to have annual fees are rewards cards and those for establishing or rebuilding credit.
— Balance transfer fee: This fee is for transferring a balance from one credit card (or more) to another. The fee averages around 3 percent.
— Cash transaction fee: Getting a cash advance comes along with a 3 to 5 percent transaction fee on the amount withdrawn.
— Foreign transaction fee: This amount averages around 3 percent, but some credit cards waive the fee altogether. This fee is applied to purchases made outside the U.S.
There might be other fees lurking in the fine print. Before you apply for a credit card, be sure you read the disclosure statements online so you know what fees come with the card.
6. What happens if I carry a balance?
This is a very, very important question. A 2017 survey for the National Foundation for Credit Counseling showed 39 percent of adults were carrying a balance from month to month. (This was 4 points higher than for 2016.)
If you pay your credit card balance in full and by the due date, you don’t pay any interest at all, thanks to the grace period.
But what if you only made a partial payment? Let’s say you owed $500 and paid $100 on your bill. This means you’d start paying compound interest on the $400 balance that you’re carrying into the next pay period.
The interest is compounded daily. So, when you made your next month’s payment, your minimum monthly payment would be a percentage of your $400 balance plus the interest on that balance. Carry this balance forward for another month, and you’d be paying interest on the original amount plus the previously accumulated interest on the principal amount.
See how insane that is? This is why I say that compound interest is evil. Don’t become a part of the 39 percent who carry a balance every month. Just don’t go there!
7. What does the credit limit mean?
This is the maximum amount you can spend with your credit card. If you go over that amount, some bad stuff can happen.
You might get charged a fee for going over the limit if you’ve opted in to do so. I suggest you don’t opt in for this. Keep in mind that this will mean your card will be declined when a purchase would take you over the limit. But if you can’t stay within your credit limit, then you shouldn’t be using a credit card.
And if you go over your limit often, your issuer might actually lower your credit limit. Or it might increase your APR or even close your account. See, credit card issuers don’t like risk. And when a young person with limited credit history is unable to stay within a credit limit, issuers feel antsy and want to rein in your spending.
8. What is a credit utilization ratio?
Just staying within your credit limit is not the goal with a credit card. You want to be mindful of your credit utilization ratio, which is the amount of credit you’ve used compared with the amount of credit you have available.
Here’s the rule to follow: Don’t use more than 30 percent of your credit limit in a given month. So, if your limit is $1,000, then you should not put more than $300 on the card. Pay this bill in full and by the due date and you’ll be on your way to good credit while you’re still in college.
When you’re a senior, if you want to give your credit score an extra oomph before you enter the real world, then keep your ratio below 10 percent and you’ll see an improvement.
9. Does the credit card offer rewards?
We just talked about annual fees. Credit cards with more robust rewards sometimes come with annual fees. You’ll need excellent credit to qualify for one of those cards, so these shouldn’t be on your radar before you graduate.
That said, some student credit cards come with rewards, and some of these have fees, but some do not. There are also secured credit cards — which require a security deposit — that offer rewards, and some of these have fees, too.
You’ll have to decide if the annual fee is worth it for you to build credit. But do stay away from unsecured credit cards that target those with bad credit. These cards have annual fees plus other costs, such as monthly maintenance fees and sky-high APRs.
10. What is your FICO score?
In a U.S. News survey, about 25 percent of students responded that they either didn’t know what a credit score was or didn’t know how to check it. If you’re going to start your credit career, you need to know about credit scores.
Your FICO score is a number that represents your creditworthiness. It ranges from 300 to 850. The higher the number, the better your credit.
Now, in the interest of (somewhat) total clarity, you have oodles of credit scores that aren’t FICO scores. But when it comes to credit cards, 90 percent of lenders use a version of the FICO score. So that’s why I’m focusing on FICO scores here.
The score is calculated based on items in your credit report. This is why you don’t want negative items showing up there. It makes your credit report look sloppy, but it also lowers your FICO score.
Your credit card issuer reports your payment history to the three major credit bureaus: Experian, Equifax and TransUnion. Payment history is 35 percent of your FICO score, so do a good job with paying your bills and you’ll start building a good credit score.
And remember Question No. 8 about the credit utilization ratio? This ratio makes up 30 percent of your credit score. Keep it below 30 percent, and you’ll be fine.
Many issuers now offer free credit scores for cardholders. There are also many websites where you can get a free educational score. It’s not the same as a FICO score, but these scores give you an idea of how healthy your credit is.
When you get close to graduating and you’re interviewing for jobs, a nice-looking credit report and a better-than-average FICO score will give you a leg up on your future. So, take the business of using a credit card seriously. Do a good job, and you’ll reap the financial rewards from it.
More from U.S. News
Credit Cards 101 for College Students
How Long Do My Mistakes Stay on My Credit Report?
30 Terms Every Credit Card Owner Should Know
10 Questions Every College Student Should Ask Before Getting a Credit Card originally appeared on usnews.com
