What You Need to Know Before Getting Your First Credit Card
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I arrived at college ready to make my own decisions. One of the first decisions I made, as I looked at a row of tables staffed by attractive 20-somethings, was which credit card to apply for. Each table offered a "prize" for filling out the paperwork. Should I spring for the free T-shirt, or would a free duffle bag be more useful?
My first credit card came with a credit limit of $500 (raised to $1,500 by the end of the semester), a high interest rate, and no rewards. And a free duffle bag that fell apart even before the issuer raised my credit limit.
More than a decade has passed since then, and I know things now that I wish I knew before signing on that dotted line.
Before you apply for your first credit card, it helps to understand how the system works. I had no idea, and I found myself in debt, with most of my money going toward interest payments, and my credit rating barely passable. (See also: Key Terms New Credit Card Holders Must Understand)
Here's what you should know before you fill out that credit card application in return for a free T-shirt.
Credit Cards and Credit Scores
First of all, credit cards are very influential when it comes to your credit score. Because credit card issuers report your credit card balance and your payment history every month, credit cards can be a fast way to build a good credit history — or a fast way to destroy your credit rating.
But why does your credit score matter in the first place? The truth is that your credit score matters a lot. Over the past 40 years, the credit score has become a representation of your level of financial responsibility. Many people don't think this is fair, but it's the way things are right now.
Later, after you've graduated, and you want to buy a car or a home, your credit score becomes exceptionally important. Lenders want to know if you will make your payments on time, and they use your credit history and credit score as a way to figure out what type of risk you represent. If you have poor credit, they assume that you are more likely to default. They might decide you aren't worth the risk and deny your loan application. What you do with your credit card now can prevent you from buying a car or a home later.
Interest Costs of a Poor Credit Score
Even if you are approved for a loan when you have poor credit, you will have to pay a higher interest rate to reduce the risk the lender is taking by giving you a loan. This can mean that you pay hundreds — or even thousands — of dollars more over the life of your loan. Just having an interest rate that is 2% higher on a 30-year home loan can mean that you pay hundreds of thousands of dollars more over the course of your loan.
By the time I finished college, I had maxed out credit cards and a credit score that was only "fair" at best. I paid for it with a 10% interest rate on the first car loan I got without a cosigner, when I could have had a 6% rate (this was before rates dropped to their relatively low levels now).
Your credit score doesn't just impact your loan rates, though. Landlords check credit, and they might deny your application for an apartment or charge you a higher security deposit if you have poor credit. In some states, insurers are allowed to check your credit and charge you higher premiums when you have poor credit.
Finally, even though employers aren't supposed to check your credit score during the hiring process (credit scores are proprietary and owned by the credit bureaus), they can look at your overall credit report (in fact, it's a specially prepared report for employers, rather than lenders). If your credit report indicates high credit card balances and late payments, an employer can decide that you are too much of a risk and decide not to hire you.
What Type of Card Are You Getting?
Don't be fooled by freebies offered by credit card reps trying to get you to apply. While it's nice to get free stuff, it's even better to get the best possible deal on your credit card. You want the right card for you, regardless of the "gift" you receive for signing up.
Your first step is to determine whether or not you are dealing with a secured credit card or an unsecured card. Secured credit cards are becoming more popular. These cards require that you add a deposit for use, and they often come with higher fees and higher interest rates. An unsecured card, though, doesn't require you to keep money in a special account as security. An unsecured card also looks better on your credit report and has better effect on your credit score. If you can get an unsecured card, that's best.
Next, look at the terms of the credit card and be sure you understand a few key terms.
Try to avoid paying a fee for using the card. Secured credit cards are notorious for charging annual and/or monthly fees.
While you might have a higher rate as a student, try to get a card with as low an APR as possible.
Check for other fees. Some credit card issuers charge high late payment fees or balance transfer fees. You should also check for foreign transaction fees. Many credit issuers have started waiving these fees, and if you can find an issuer that won't charge them, these cards can be great choices if you plan a trip overseas.
Rewards are another consideration. Does the card offer cash back? Is there a points system that can provide you with the ability to get free travel or merchandise? Choose a credit card that offers you rewards that you will actually use. However, realize that the value of the rewards means nothing if you carry a balance from month to month. What you pay in interest on a carried balance will offset — and completely overwhelm — any rewards benefit.
How to Use a Credit Card to Best Effect
If you want to get the most out of your credit card, you need to have a plan. Get a credit card with low fees and a low APR, as well as rewards that make sense for you. Then, only buy what you can afford in the first place. Pay off your balance on time, and in full, each month.
When you pay off your balance each month, you keep your credit line open, and it looks good on your credit report. The most important factors influencing your score are payment history (whether you pay on time), and your debt utilization ratio (how high your balance is compared to your credit limit). If you can pay on time, and keep your balance low, you will build up good credit quickly.
Don't forget to regularly check your credit report. You are entitled to a free report from each of the major bureaus every year. Go to AnnualCreditReport.com and use the resources at the Consumer Financial Protection Bureau to keep tabs on your credit situation and learn more about the protections available to you.
Were you caught by any surprises with your first credit card? Let us know in comments!