The Forbes Guide to Credit Cards

The credit card had a humble beginning. Diners’ Club introduced the first general-purpose credit card in 1950, followed eight years later by the first bank issued credit card. Americans have been using plastic credit cards since 1959 when American Express introduced plastic to replace its cardboard predecessor.

Today, credit cards have become ubiquitous in the United States. According to the Federal Reserve, Americans used their credit cards to pay a record 40.8 billion times in 2017, and those payments totaled $3.6 trillion. Statista reports more than a billion credit cards in the U.S. today and, according to the Federal Reserve, credit card debt now surpasses $1 trillion.

There are several reasons for the explosion of credit card use. One is the security and convenience of using a card instead of lugging around loads of cash. Another reason is the boom in online shopping. There’s also the number of banks offering compelling cash and travel rewards to their card users. Some credit card issuers offer a 0% introductory APR on purchases or balance transfers as a way to market their cards. And then there is a credit card’s ability to help consumers build a credit history and score that will help them later if they want to take out a mortgage, borrow for a car, or do anything else (like rent an apartment) that might require a credit check.

In this Forbes Guide to Credit Cards, we cover these and other topics you need to decide whether and how credit cards should be part of your financial life.

What Is a Credit Card?

Credit cards, which are a form of revolving credit, work differently than installment loans. With an installment loan, such as a car loan, a consumer borrows a fixed amount of money at a fixed or variable interest rate. A minimum monthly payment is set in advance, and it doesn’t change over the course of the loan.

With credit cards, it’s a different ball game. First, most credit cards come with a credit limit. A credit limit of $10,000, for example, enables a consumer to charge up to $10,000 on the card. Of course, there is nothing requiring the cardholder to use any or all of the available credit.

Second, the minimum payment on a credit card varies based on the outstanding balance. As the outstanding balance goes up, so does the minimum payment. Conversely, as the balance goes down, the minimum monthly payment also goes down.

Third, there’s no term on revolving debt. A car loan, for example, typically has a set term (e.g., 5 years). With a credit card, a consumer can continue to use the card so long as the balance doesn’t exceed the card’s credit limit.

The Types of Credit Cards

There are several different types of credit cards. These include cards for those with no credit or poor credit, business cards, and those looking for rewards. Here are the major types of credit cards available today.

Secured Credit Cards

In the world of credit cards, you’ll find there are two broad categories: secured and unsecured. Both report your payment history to credit reporting bureaus. Most credit cards you see advertised are unsecured, meaning they don’t require a refundable deposit to use them. Secured credit cards, on the other hand, require a security deposit to open the account.

Secured cards will likely have the word “secured” attached to its name—for example, there’s the  Discover it® Secured card. To use this card, you’d deposit $200 to open a $200 line of credit with Discover. After eight months, your account, along with your other credit accounts, are reviewed monthly to evaluate your credit management. At that point, assuming you have paid off your balance every month and managed your other accounts well, Discover will likely refund your deposit and switch you to an unsecured card.

Unsecured Credit Cards

Unsecured credit cards are what most people think of as traditional cards. What follows are various types of unsecured credit cards.

Student Credit Cards

A student credit card is designed for college students with limited or no credit. Student cards usually come with low to no annual fees and an educational component in the form of rewards. Some banks and credit unions will offer statement credits for maintaining a certain grade point average, for example. Other card features include cash back or rewards points. The credit limit on student cards is often low given the applicant’s limited income and credit history.

Business Credit Cards

There are two types of business credit cards: small business and corporate. Card issuers will have different qualifications for each card. For example, what one bank considers a small business, another might not.

A small business credit card operates like a personal credit card and it’s commonly used to establish credit for a young business. It’s similar to a personal credit card in that the small business may not have enough credit history to get a corporate card and so the business owner applies for credit through their own name.

Businesses that have more scale and a credit rating from one of the business credit rating agencies meet the requirements for a corporate credit card. Corporate credit cards give companies with millions in revenue the flexibility of authorizing multiple users and earning business related rewards like air mileage.

These cards aren’t hard to come by so you can shop around to find one that meets your business needs.

Reward Credit Cards

Credit cards offer a variety of valuable rewards. From cash back to free travel, rewards credit cards seek to build loyalty with card holders by rewarding them when they use the card.

Here are the major types of reward credit cards:

Cash Back Credit Cards

A cash back credit card offers discounts on purchases by giving cardholders cash in the form of a check, direct deposit or a statement credit. Cash back rewards typically range between 1% to 6% on purchases. For cards that pay the same rewards percentage on all purchases, the rewards range is from 1% to 2% in most cases. As the rewards rate rises above 2%, the rewards are limited to specific categories of purchases.

When choosing a cash back credit card, look for one that matches your spending habits. For example, if you spend a lot on groceries, you could choose a card that gives you a higher cash back rate at grocery stores. If you value simplicity, however, you could choose a card that offers 2% in unlimited cash back on all purchases.

Another feature to consider is monthly and annual fees. If your annual fee is equal to or bigger than your one-year cash back earning potential, it may not be a good fit for you unless you’re looking for the cash back to cover that fee. Likewise, if your interest rate is high and you will likely carry a balance, then you may not even get a chance to enjoy cash back rewards, since those rewards are likely to be more than offset by the interest you pay.

Look at when you can redeem the cash back, as well. Some cards give cash back after you’ve earned a number of points at certain merchants, others give cash back after a certain number of days or months, and some give you instant cash back. Read the redemption process for earning cash back to determine if its worth your time and energy.

Travel Reward Credit Cards

Credit cards are tools that can be aligned with your lifestyle. Travelers looking to earn mileage or discounts on hotels and travel packages have travel reward credit cards as an option. There are bank cards that are great for general travel and then there are branded cards that are great for flights on specific airlines or stays at specific hotel chains.

You could get a travel rewards card through a financial institution such as your bank. Bank of America’s Travel Rewards credit card gives you unlimited 1.5 reward points for every dollar you spend, plus 25,000 bonus points when you spend $1,000 or more within the first three months.

Some travel reward credit cards double as branded cards. Airlines offer credit cards that help you accumulate frequent flier points, which you can redeem for flights, free checked luggage, preferred boarding or discounts with their partners like other airlines. American Airlines partnered with Citibank to produce the AAdvantage Platinum Select World Elite Mastercard, which comes with all sorts of bells and whistles such as earning up to 50,000 bonus miles.

Hotel reward cards carry similar benefits. You would use a hotel card to earn points towards discounted rates, room upgrades, extended checkout or a free stay. The IHG Premier Rewards Club card gives free stays to cardholders on their card’s renewal anniversary.

Maybe hotel and flight discounts don’t excite you? Car rental companies like Avis offer credit cards, too.

Once again, pay attention to the fine print of how you can earn points, as well as how you will redeem those points. Some travel rewards programs may require you to cover your own taxes when redeeming your travel points—meaning, for example, that a free flight might not be really free.

Branded Credit Cards

Stores and other merchants partner with card issuers to create cards offering rewards or cash back. The Amazon Prime Rewards Visa Signature by Amazon.com, Chase and Visa Signature gives Amazon Prime members 5% cash back on purchases made on the site and at Whole Foods stores.

Charge Cards

Unlike credit cards, which allow you to carry a balance into the following month for whatever interest charge you qualify for, charge card issuers require that you pay your balance off every month. If you choose not to pay the balance off, you will incur a fee.

Another difference is the credit limit. Charge cards do not have a pre-set spending limit; however, there are some retail charge cards that do. No pre-set spending limit doesn’t mean you access to endless credit. The bank can limit your credit to your regular usage of the card or your payment history.

Though charge cards are no longer as commonplace as credit cards, some financial institutions still offer them. They are helpful tools for people who prefer to not have long-term debt.

These cards may come with rewards programs, too. With American Express charge cards, for example, reward points could be one to five times your purchase amount. The only downside is these cards tend to come with high annual fees.

Subprime Credit Cards

Subprime credit cards are designed for borrowers who have poor credit scores.  Subprime cards often come with exorbitant fees on top of high interest rates. There are some, however, such as the Credit One Bank Visa, that keep their fees and interest rates in line with standard rates. If you have poor credit, your goal should be to rebuild your score so you can qualify for lower interest rates and save money in the long run.

0% Introductory APR on Purchases and  Balance Transfers

Some credit cards offer an introductory 0% APR. The 0% annual percentage rate is an introductory feature. Once you reach the end of the introductory period, the rate goes up to a standard credit card interest rate. Credit card companies may extend their 0% APR offers to purchases, balance transfers or both.

It’s important to understand the difference between 0% on purchases and 0% on balance transfers. With purchases, consumers pay no interest on their balance during the introductory period. Once the introductory period ends, the interest rates goes to the standard purchase rate based on the cardholder’s individual’ creditworthiness.

Balance transfers work differently. Knowing that consumers want to avoid interest charges on their revolving debt, some issuers offer balance transfer promotions to obtain new customers. Once the customer is approved, she can transfer her balance from an existing credit card to her new credit card with a 0% APR. While she’ll benefit from the 0% APR during the introductory period, most balance transfer cards charge a transfer fee of 3% to 5% of the amount transferred. A few cards, like the Chase Slate card, waive the balance transfer fee for those who initiate the transfer within a set period of time.

As previously suggested, shop around, compare features and go with a card that benefits you the most.

Prepaid Debit Cards

Prepaid debit cards are not credit cards and they don‘t help you build your credit history. But if you do not have a bank account or if you want more control over your spending you might choose to use one of these cards for convenience. That’s because prepaid cards generally can be used anywhere that accepts credit cards.

Prepaid cards operate similarly to checking account debit cards. But since a prepaid card doesn’t have a checking account to draw from, you must first load money onto it before you can use it. Prepaid debit cards are reloadable, so you can continue to use the same card again and again.

There are a variety of ways to load money onto a prepaid care. For example, they generally accept direct deposit of paychecks, tax refunds, and government assistance payments. Many cards offer account access online and through a smartphone app. They also offer text alerts for low balances or other account changes. Prepaid cards often come with extensive fees, so one must understand the card’s fees before selecting a prepaid card.

Credit Card Networks

American Express, Discover, MasterCard and Visa are the largest credit card networks in the U.S. The most widely used network is Visa. According to Statista, an online market research portal, Visa had 337 million credit cards in circulation in the U.S. in the fourth quarter of 2018. Visa is accepted at over 46 million merchant locations, used by nearly 16,000 financial institutions and in over 200 countries, MasterCard had 231 million credit cards in U.S. circulation at the end of 2018 and AMEX had 54 million.

The Pros and Cons of Using Credit Cards

The Pros:

• Protection – Federal consumer protection laws provide that your personal liability for credit card fraud is a maximum of $50 if you report that your card is lost or stolen within two days of realizing it.  (Many credit card companies, however, offer $0 liability so long as you timely report the loss.) If you don’t report a card theft or loss within two days, your liability increases to $500. If you still have physical possession of your card and there are fraudulent charges made on it, you have $0 liability so long as you report the fraud within 60 days of the time your card statement showing the fraud is sent to you.
• Convenience – Credit cards are easy to use because they are accepted by most merchants, they are handy for moments when you don’t have cash and if a card is lost or stolen, your potential liability is limited.
• Rewards – Credit card issuers like to reward customers for their business or loyalty with discounts and prizes.

The Cons:

• Easy to Accumulate More Debt – Spending past what you can afford and missing your payments equals more debt than you can handle and a poor credit score.
• Convenience – The convenience of these cards encourages people to spend more and use it more frequently than if they only had cash or a debit card. A 2001 study by Drazen Prelec and Duncan Simester on willingness-to-pay illustrates that participants were more willing to pay for an item when they were told to use credit instead of cash. It’s good business for banks, but it can be bad for your net worth..
• High Interest Rates and Fees – These can get you into more financial trouble when you fall on hard times.

Credit Cards and Your Credit Score

We can’t give you a guide on credit cards without discussing credit scores. Credit card issuers use credit scores, which are based on your ability to manage credit as reported in your credit bureau file, to evaluate your creditworthiness.

Between VantageScore, FICO scores and specialty credit scores for renting or employment, you have many different credit scores. The one most widely used by credit card companies is a FICO score, which ranges between 300 and 850. The lower the score, the more of a credit risk you seem to creditors. The higher the score, the more creditworthy you seem to creditors.

Your FICO score is based on five factors:

• your payment history (35%)
• the share of your credit lines you are using (30%)
• the length of your credit history (15%)
• the diversity of your credit (10%)
• new credit accounts you have opened in the past 12 months

Once you’ve applied for a credit card, the issuer performs a hard pull on your credit report to evaluate your creditworthiness. They might look at how much of your available credit you are using, how long you’ve held credit and if you are good at paying off your balance (or at least keeping it low). They also might check how many credit accounts you’ve recently opened and what type of credit you have received. What a credit card company looks at depends on that company’s approval process.

The credit pull helps credit card companies decide how high an APR you are eligible for. High credit scorers (700 and above) could qualify for a lower interest rate compared to low scorers. Credit card users who prefer to carry a balance instead of paying their balance off every month should aim to get the lowest interest rate. That way, they’ll pay less interest.

Use your credit cards with your credit score in mind and allow it to work for you, not against you.

Credit Card Sign-up Bonuses

Banks, especially major ones, offer bonuses for switching to their services. Common sign-up bonuses include cash bonuses of up to  hundreds of dollars, if you spend a certain within the first several  months of opening a card. These case rewards can come as statement credits on your bill, or even checks. Credit cards that offer reward points also offer sign-up bonuses equal to thousands of points that can be redeemed for merchandise or trips.

Pay attention to the fine print. Some banks will use the bonus as a token of their appreciation for your business while others will make you jump through hoops. You could find a bank who will give you cash for simply opening a new account with them. Or, you might choose a credit card where you would have to spend a few hundred or even a few thousand dollars to qualify for the sign-up reward. The fine print will tell you what you have to do to qualify for the sign up bonus. It will also tell you whether you would qualify to participate in getting the bonus. Some issuers will clearly state in the section that you are not eligible for the bonus if you’ve already received one from them within the past one or two years.

There are a couple of other things to watch out for with sign up bonuses, including hidden fees that could diminish your bonus. Finally, be sure to compare other sign-up bonuses currently offered by the same bank for other cards (they may be even higher) and by other banks.

Credit Card Fees

Types of credit card fees:

• Late payment fee: Credit card issuers charge you a fee for any payments deemed late.
• Balance transfer fee: When you transfer your balance from one card to another, you may incur a fee on the card receiving the balance transfer.
• Cash advance fee: You may find yourself in a situation where you need cash  and you don’t have your debit card on you. You can withdraw cash from your credit card for a percentage fee.
• Foreign transaction fee: When you use your credit card outside of its country of origin, the issuer will charge you a fee to cover the costs associated with using a foreign bank or foreign currency. Some cards, particularly those that are travel-related, waive this fee.
• Over-the-credit limit fee: This is much like the overdraft fee you see with checking accounts except it’s a charge the issuer adds to your bill for covering a transaction that went over the card’s credit limit.
• Annual fee: This is an account maintenance fee that you would pay annually. Some accounts make you pay monthly. Many cards come without an annual fee.
• Returned payment fee: When your credit card payment fails to go through because of insufficient funds, the card issuer will charge a fee.
• Convenience fee: Some merchants will charge you a fee for using a credit card instead of cash.

Managing Credit Card Debt

People manage their credit card balances in two main ways and be described as either revolvers or transactors.

Revolvers leave a balance on their card and repay what they borrowed over time. They may make minimum payments, which carries interest and a bit of the principal, or chip away at the balance with a larger than minimum payment. Timely minimum payments keep you in good standing, but they also lengthen your time repaying the debt and cause you to pay more in interest. Because of this, we recommend revolvers aim for credit cards with low interest rates to save money.

Transactors are people who pay their balance off at the end of every month. These people might not worry about interest rates much since they avoid interest charges by paying off their balance in full each month. Instead, they should generally opt for credit cards that offer the highest rewards.

An interest rate, also known as the annual percentage rate (APR), is the yearly cost of the credit you are borrowing from a financial institution. A financial institution could be a traditional commercial bank, credit union or an investment bank with banking services. The APR is determined by your creditworthiness (i.e. credit score) and also by what you do with the credit card.

Some credit cards charge different APRs for different types of transactions. For example, the APR on purchases can be different than the APR on cash advance. A penalty APR can be even higher and apply when a cardholder violates the terms of the credit card agreement (e.g., missing a payment or going over the credit limit). If you slip into a penalty APR, you could go, for example, from paying an 18% APR on an outstanding balance to a 29% APR.

Grace Period

To avoid interest charges, you’ll need to be a transactor and pay your debt off every month by the due date. The time between the end of your billing cycle and due date is known as the grace period. Grace periods are at least 21 days and last up to the payment due date. By paying during the grace period, you avoid interest and only pay for the purchases.

When you fail to pay during that period, you incur interest and usually, a late payment fee. If you make a partial payment or a minimum payment instead of paying off your bill in full, you will also incur interest. What’s more, you’ll end up waiving your grace period for the next billing cycle until the bill is completely paid.

Balance Calculation Methods

Credit card companies have a few different ways of calculating interest. They can use either a daily periodic rate or a monthly periodic rate. The daily periodic rate takes the APR and divides it by 365 and then multiplies that number by the number of days in the billing cycle. Next, banks take that figure and multiply it by the outstanding balance. The monthly periodic rate is similar except it is the APR divided by 12 months.

Differences in  calculation methods don’t stop at periodic rates. The rates are applied to the balance in various ways such as the adjusted balance, the average daily balance excluding new purchases, the two-cycle average daily balance including new purchases and the two-cycle average daily balance excluding new purchases. The least expensive are the adjusted balance and average daily balance (ADB) excluding new purchases. The most expensive are two-cycle ADB including new purchases  and the two-cycle ADB excluding purchases.

Adjusted Balance

Credit card issuers charge an interest (1/12 of the APR) on the remaining unpaid balance after payment is due.

Average Daily Balance

For the average daily balance, credit card issuers charge interest from the date of the purchase. If payment hasn’t been made by the due date then interest will accrue. The bank decides whether new purchases will be included or excluded from each billing cycle.

Here’s an example calculation

Daily balance with new purchases = Beginning balance – (payments + credits) + (purchases + fees)

ADB = Sum of Daily Balances / Number of Days in the Billing Cycle

Two-Cycle ADB

This method has fallen out-of-style, but it still exists. The two-cycle ADB adds a current billing cycle with the billing cycle before it to calculate your interest. According to the Consumer Finance Protection Bureau, both the current and previous balances are calculated the same. The balances (including or excluding new purchases, and subtracting payments along with credits) of each day are added together and then divided by the number of days in the billing cycle. As you would imagine, this balance calculation method is expensive for the cardholder..

Making the Minimum Payment

When you make the minimum payment on a credit card bill, you are paying a percentage of the principal and the interest that accrued for that billing cycle. Usually, the minimum payment is a percentage of your balance, plus any interest and fees.

Minimum Payment = % of the balance + any interest and any fees 

In your card member agreement you’ll find information about how you are charged an interest rate, what that interest rate is and what percentage of your balance will be your minimum payment. For example, my credit card agreement states that my minimum payment will be 1% of my balance plus the interest that accrues over my 26-day billing cycle. The interest doesn’t get applied until the end of the billing cycle.

Paying the minimum means you plan to carry a balance into the next billing cycle on your credit card. If you don’t pay the balance off in full by the next bill then your minimum payment will increase because you will have accrued more interest.

Making the minimum payment is one option in paying down your debt, but it takes longer and costs you more. The longer you wait to pay off a balance, the more you pay in interest (the fee the credit card issuer charges you for borrowing its money). To some cardholders, the minimum seems like a good idea since you’ll have more cash in your pocket, but there’s better ways to pay off your balance. It’s important to note that you should always—at least—pay the minimum to keep your payment history in good standing.

Low Interest Rate vs. Rewards

If you are searching for rewards cards, weigh the cost of the card against the rewards. As suggested before, revolvers should aim for cards with low interest rates. The rewards (points, miles, cashback) that are part of high interest cards may not outweigh the costs in fees and interest.

Credit Cards should be seen as tools and not as goals. Your goal should be to be as financially healthy as you possibly can. You can use credit cards to do that by choosing ones that will maintain or improve your credit file and score, enhance activities you already do such as travel, protect your cash and and are convenient.

-Asian Martin; Forbes Staff