Learning to Use a Credit Card Responsibly

To quote Uncle Ben from Spider-Man, “With great power comes great responsibility.” While comic book writer Stan Lee intended the proverb to apply to the film’s eponymous hero, his words also apply to the power of credit cards. Using one correctly can provide you with unparalleled security, convenience, and creditworthiness.

However—and there’s always a however, right?—the key is discipline. People that lack it end up spending money frivolously, paying thousands of dollars in unnecessary interest, and tanking their credit score. Let’s talk about how to use a credit card responsibly and reap all the potential benefits.

How credit cards work

Before we dive into responsible credit-card habits, it’s crucial to understand how they work. By comparison, you wouldn’t hand someone a dangerous power tool without showing them how to use it, right? The same applies here.

Credit cards are the equivalent of a short-term loan. You can use the physical card (or the card number, if online) to make purchases, withdraw money, or pay bills. The credit card company allows you to make transactions up to a specified credit limit—a total that depends on your credit history.

When you use your credit card, the merchant doesn’t receive funds directly from you. Instead, a credit card network approves the transaction and makes the payment on your behalf. You have to pay that credit card network back for your transactions at the end of the billing cycle.

If you pay your balance in full every month, the bank doesn’t charge you anything for what was essentially a very short-term loan. But they will charge you interest on the amount you do not pay off at the end of the month. This interest rate is called the annual percentage rate (APR). 

Credit cards have relatively high APRs because companies don’t come with collateral to secure them. According to The Balance, the average APR on credit card purchases is 20.24%. And believe us, that adds up fast, so you want to do whatever you can to avoid paying that.

Tips for being a responsible credit-card user

Make credit card payments on time

Making timely payments goes hand-in-hand with responsible credit card use. Credit bureaus and lenders see it as a sign of a reliable and trustworthy borrower. It also makes lenders more likely to loan you money with favorable terms in the future, whether you’re buying a car, starting a business, or going to college.

All credit cards have a grace period, representing the time between a transaction and the due date on your statement. Grace periods vary between card issuers, but they must last at least 21 days from the end of the billing cycle, as mandated by the Credit CARD Act of 2009. You do not have to pay the balance during this time, and your debt does not accrue interest.

As long as you pay the statement by the due date, you’re fine. If you exhaust the grace period, your balance will carry over to the next month, and you’ll have to pay interest. The next month, you’ll be paying interest on your interest! And so forth. 

If you don’t pay on time, you may also see a late fee added to your balance, and late payments result in a negative impact on your credit score. FICO, the credit-scoring service, ranks payment history as the most critical factor in its formula.

Pay your balance in full

If you take away one thing from this article, it should be this: Pay your balance in full every month. It’s the single best thing you can do for your financial present and future. Not only will it reduce your monthly debts, but it will improve your credit score and creditworthiness.

Too many people fall into the minimum payment trap. Instead of paying off their balance in full, they make the minimum payment of $15 or $25. Their balance then carries over to the next month and forces them to make exorbitant interest payments on top of the subsequent bill.

Let’s say you had a bill for $1,500 last month. Money is tight, and you decide to make the minimum payment of $25 with 20% interest. The following month you rack up charges of $1,500. Now, you’ll have to pay $3,270 because the previous bill carried over with interest.

The problem is that credit card companies want you to make the minimum payments. Trapping customers into a cycle of increasing debt—and rising interest payments—is one of the ways they make money. It’s not a coincidence that the “minimum payment” is in a prominent, easy-to-read position on your monthly statement, while the option to pay your bill in full is off to the side.

Use a card that adds value via cash back or travel rewards

Choose your credit card company wisely. If you do, you can earn hundreds of dollars in “free money” over the year. All you have to do is spend your money on everyday items.

A travel credit card allows you to earn points or miles with every purchase and redeem them to pay for your travel expenses. With a co-branded card, you can redeem rewards within a single loyalty program, which limits availability for flights and hotel stays. A general-purpose travel credit card is a flexible alternative to co-branded cards if you are not loyal to a specific hotel chain or airline. 

With a cashback card, you earn rewards in dollars, which you can redeem for a check, direct deposit into your account, a credit on your statement, or gift cards. Some cards currently offer 2% cashback on every purchase or up to 5% cashback on certain purchases. Most cashback cards don’t charge annual fees, and the redeeming process is quick and straightforward. 

While a cashback and other rewards can pay dividends, you should not let them dictate your financial decisions. Chasing rewards can be a counterproductive trap if you make exorbitant expenditures for the sake of points. It’s more important to get points that align with your spending habits so that you will not feel the impulse to overspend. 

Understand when not to use a credit card

You may feel a temptation to use your credit card for everything. When you use one long enough, it may begin to feel like a natural extension of your body! All you have to do is swipe that plastic rectangle, and you’re the proud owner of groceries or a new pair of sneakers.

Just because you can use your credit card doesn’t mean that you should. There are times when it’s better to curb your spending habits for the sake of your wallet. These include:

• When you want to lower your credit usage or credit utilization rate
• If you often spend more than you can afford
• If you have trouble paying your balance on time or in full every month

Part of understanding how to use a credit card responsibly involves budgeting. That means tracking every penny that goes in and out of your bank account. If you need a helping hand monitoring your budget, consider downloading a mobile app, such as Acorns, YNAB, or EveryDollar. 

Manage your credit utilization

The odds are that you didn’t like flossing or brushing your teeth as a kid. You still might not enjoy those activities today. Taking two minutes to flex your hygiene each day, though, can make an enormous difference when it comes to your oral health. 

Small, incremental habits also work with credit cards.

Every credit-related transaction you make impacts your credit score. That includes credit card payments, credit mixture, credit age, and inquiries into your credit history. If you take care of each of these components, you won’t have to worry about the equivalent of financial cavities.

One barometer of your credit strength is the credit utilization rate. This formula only applies to credit cards. You can calculate it by dividing your total debts by your total available credit.

Let’s say you spent $1,500 last month. Your credit card company has given you a credit limit of $10,000, making your credit utilization rate 15%. As a rule of thumb, financial experts recommend a rate below 30%. So at 15%, you’re fine. But as it starts to creep upward, it will cause your credit rating score to creep downward.

Many of the habits on this list will help you improve your credit utilization rate. Additional tips include opening new credit card accounts and requesting a raise to your credit limit. You should also keep credit accounts open if they have zero balance, even if you don’t use them. Even though that seems counterproductive, it all feeds into the formulas that FICO uses to calculate your credit score.

Use fraud alert services

Errors happen on credit reports. If they happen to you, they can artificially lower your credit score. The best way to counteract potential errors is through fraud alert services and credit score monitoring.

Some credit card companies offer fraud protection as a complimentary feature. You can take advantage of state-of-the-art security at financial institutions like Wells Fargo and Discover. Not only do they offer fraud and credit-score-monitoring services, but they have EMV chips to prevent credit card skimming and can freeze your account in case of an error.

You can also do fraud monitoring on your own. All three national credit bureaus (Experian, Equifax, and TransUnion) have a legal obligation to provide consumers with one free credit report per year. All you have to do is visit annualcredireport.com to get started and obtain your credit score and report.

Review the credit report and your monthly credit card statements for suspicious activity. Some of the most common errors include misattributed accounts and incorrect personal information. If you spot an error, reach out to all three credit bureaus and ask for a correction.

Why not just use a debit card?

With a debit card, you can only make real-time payments, which holds you accountable for your spending. You also avoid high interest charges, which amount to significant savings over the long-run. 

However, if you only use a debit card, you miss out on several financial and security benefits. With a credit card, you get a free short-term loan, provided that you pay your bill in full. Using a credit card also allows you to build a positive credit history for mortgage down the road, earn rewards on everyday purchases, pay for rental cars, or make hotel bookings. Credit cards also offer better fraud and purchase protection than debit cards. 

Conclusion

Credit cards can be dangerous, but with responsible use, they can be instrumental in managing your cash flow and building a solid credit history:

• Make your payments on time.
• Pay your balance in full every month.
• Don’t max out your card.
• Keep an eye on your credit.
• Use a card that pays you back.