A credit card can help you build credit, make convenient payments, and meet everyday expenses in your life. Getting an understanding of how credit cards work can teach you about the benefits of having one over a debit card. Knowing the ins and outs of credit cards will provide useful insight into managing your debt more responsibly.
What Is The Difference Between Credit, Debit, And Prepaid Cards?
There can be some confusion when it comes to the difference between credit cards, debit cards, and prepaid cards. To help clear this up, here’s more information about the cards:
Experian defines a credit card as “a card issued to consumers that is used to make purchases, with the agreement that the cardholder will ultimately pay back the card issuer for the cost of the items purchased, along with any agreed upon fees and interest, should they be assessed.” Basically, it is a card that acts as a loan that allows a person to make purchases now and pay credit card companies back later.
Investopedia defines a debit card as “a payment card that deducts money directly from a consumer’s checking account when it is used. Also called ‘check cards’ or ‘bank cards,’ they can be used to buy goods or services; or to get cash from an automated teller machine or a merchant who\’ll let you add an extra amount onto a purchase.” Usually, people use this type of card when they don’t want to carry cash or affect their credit card score.
Capital One defines a prepaid card as a card that “can be used to make purchases, similar to a debit card. But when you get a prepaid card, it comes with a balance that acts as your spending limit. Once you’ve spent the balance, the card becomes unusable until you add more money to it.” Typically, people use this type of card when they want to limit their spending or want an extra layer of security.
5 Types of Credit Cards
Before you decide to get a credit card, take a look at the different types so you can decide which one is right for you.
- Rewards: This is a credit card that gives you something back for each purchase you make. Generally, these cards require good credit. Some examples of rewards include cash back, points, and travel miles.
- Low-Interest: These cards provide value with a lower interest rate, making it less expensive to carry a balance.
- Balance Transfer: A balance transfer credit card lets you move your debt from another issuer to take advantage of a lower interest rate.
- Cards for Poor or Average Credit: In most cases, this credit card option is used to help improve someone’s FICO score so they can qualify for a better card longer down the road. Plus, interest rates are usually higher.
- Student Cards: Typically, college students can only get a credit card if they are over 21, have proof of income, or have a co-signer.
Credit Card Holder “Must Knows”
While there are benefits to using a credit card like rewards for purchases, being able to pay over time, and more, there are some things to be cautious of so you don’t get hurt financially.
- Credit Card Debt: With a credit card, there is an incentive to spend more money. It can be easy to overspend and then not have the money to pay back at the end of the month, which can put you in debt. We encourage you to pay back the minimum plus anything extra to go towards the balance if you are able to.
- Credit Card Fees: You will be charged fees for making a late payment and they can add up quickly! This means your fees are then charged interest as well. Having an understanding of how compounding interest works, as well as knowing your billing period, can help you coordinate payments and avoid fees.
- Short-Term Credit Hit: Every time you open a new credit card account, your credit score will take a quick hit. For that reason, it’s a good idea to never open a credit card right before you need the best credit score possible; for example, applying for a loan.
- Credit Score: A credit card can build or ruin your credit score. A FICO score is based on payment history (35%), accounts owned (30%), length of credit history (15%), credit mix (10%), and new credit (10%). Every month, your issuer will report your credit card activity to credit bureaus and they will compile the credit reports that form the basis of your credit scores.
Still interested? Now it’s time to apply what you’ve learned from this article to make decisions on which credit card is best for you and how to improve your credit score while minimizing debt. If you get rejected for a credit card, use it as a learning opportunity! The card issuers are required by federal law to send you an explanation for their decision, called an adverse action notice. This feedback could help you decide how to improve your chances of approval next time.