When used responsibly, credit cards offer extraordinary perks. The key is to avoid interest and fees by paying off your balances in full after making a purchase. That means using a card to spend just like you would with cash or a debit card, not using your credit limit to make purchases you otherwise couldn't afford.
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Here's the simple guide for how to use a credit card to get the most benefit without any of the sky-high costs most people associate with credit cards.
For everyday purchases
Credit cards aren't very well understood by the general public, especially when it comes to the interest they charge. The reality is that as long as you always pay your bill in full, you'll never pay a dime in interest, even if the card charges an APR of 25%, or even more. That's because credit cards have what is known as a grace period, or a certain amount of time before interest is charged to your balance.
To avoid any interest on your purchases, all you have to do is pay the "statement balance" each month when the bill comes due. This amount will be clearly labeled on your credit card statement, and it should be greater than or equal to the minimum payment amount.
People who use credit cards as a replacement for debit cards (to purchase things they can afford without carrying a balance) get more fraud protection and up to 2% cash back on everyday purchases. If you spend responsibly, it's almost irresponsible not to put your purchases on a cash-back credit card.
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For getting big cash back and travel rewards
The hurdle for a good cash back or travel card is 2%. A cash back card should generally offer 2% cash back or more on every purchase. The same goes for travel cards, which should offer value roughly equal to 2% of every purchase you make to the card.
This can get a little complicated, since some cards pay out in "miles" or "points" rather than simple cash, but we've curated a list of the best travel and cash-back credit cards that generally reward cardholders with at least 1.5% on every swipe of their card, either in the form of cash or in travel value. These cards can be more rewarding when bonuses and bonus category spend is taken into consideration. (For example, some top cards offer double rewards on restaurant and travel spending, bringing up the overall average rewards rate.)
Used responsibly, cash-back and travel cards can be an excellent way to benefit from purchases you would otherwise pay for with cash or debit. Importantly, thanks to sign-up bonuses, the effective rewards rate in the first few months on a top-tier travel or cash-back card can easily equate to a 10-15% net rewards yield. The best sign-up bonus currently offers travel rewards worth $625 in travel value on the first $4,000 of purchase volume, equating to an effective rewards rate of nearly 16% on the first $4,000 of purchases.
For financing a major purchase at 0%
Credit cards offer perks to new cardholders that can include 0% promo APRs on purchases for as long as 21 months. These promotional periods can be very useful for people who need a way to finance a major necessary purchase like a new fence for a backyard, a major repair to a car, or a new heating unit for your home before winter arrives.
During these 0% APR intro periods, cardholders can effectively use a credit card as an interest-free loan. In the most extreme case, one could use a new card with a 0% promo APR for 18 months to make a $10,000 purchase. By making equal payments of approximately $556 per month, every month, the balance will be repaid in full before interest is charged to the card in the 19th billing cycle.
Of course, this takes some planning ahead, since 0% APRs are usually only doled out to new cardholders, but the reward is pretty good. Considering that the average two-year personal loan carried a rate of 10% 2017, a 0% APR on purchases from a credit card is a pretty good deal.
For paying down credit card debt
It's my view that credit cards offer the single best way to get out of credit card debt without paying sky-high interest on the balances. Some of the best balance transfer cards allow cardholders to transfer their balances to their new card with no fee, on terms that include up to 15 months of 0% interest on the balance.
The potential savings are massive. Consolidating a $3,000 balance and a $2,000 balance on a new balance transfer credit card could save you as much as $620 in interest over a 15-month 0% APR promo period. The key is to use the card for the balance transfer, then put it in your sock drawer. It's important not to carry ordinary purchase balances on a 0% APR credit card unless the card offers 0% APRs on purchases, too.
For building and maintaining good credit
A credit card can help you build and maintain a great credit score that will yield rewards for the rest your life in the form of lower interest rates on car loans or mortgages and even lower insurance premiums. It's true -- just one open credit card, managed responsibly, can lend to a superprime credit score of 760 or higher.
The key is avoiding potential pitfalls.
- Never pay late. Late payment fees can add up to $30 or more, but that's nothing compared to the damage they can do to your credit score. A serious delinquency can easily send your credit score down 100 points or more, which can be the difference between "super prime" and "subprime." Luckily, late payments are not reported to the credit bureaus until they are more than 30 days late.
- Never carry a big balance. Ideally, you should keep your credit card balances lower than 30% of your credit limit in any given month. One of the most important factors that goes into your credit score is credit utilization, or your balances as a percentage of your credit limits. A credit utilization ratio greater than 30% (more than $300 of balances on a $1,000 card) will result in a lower credit score, all else equal. Your account information is reported to the credit bureaus once per month, meaning that your utilization ratio will fluctuate from month to month. If you plan to apply for other forms of credit -- say, to buy a home or car -- paying down your cards a month before applying is a good way to maximize your score at the time of application.
Opening a credit card account and managing it responsibly is one of the best -- and free -- ways to build or rebuild credit. There are cards for everyone, even people who have credit scores that don't lend themselves to an instant approval. If you have bad credit, a secured credit card offers a high chance at approval and the opportunity to start building good credit history to replace the bad. On the opposite end of the spectrum, top-shelf sign-up bonus cards offer the opportunity to collect $500 or more of travel or cash value within the first three months of opening the card, in addition to all the benefits to your credit report.
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