An Illustrated Guide to Credit Cards

We break down (almost) everything you need to know

There are a few good reasons to use credit cards:

1. To build a credit history (maintaining a high credit score can help you land a great apartment, or lead to better interest rates on loans and mortgages)
2. To earn cash back rewards, points, or airline miles
3. To receive purchase protection, extended warranties, and other credit card benefits

There are also a few… less good reasons to use credit cards:

1. To buy items you cannot afford
2. To buy items you cannot pay off in full with your next paycheck
3. To fund once-in-a-lifetime experiences like vacations or weddings

“Hold on!” I can hear you thinking. “I know how credit cards work. You get one of the cards with the introductory 0% APR, you put your vacation tickets on it, and you pay off the whole thing before the 0% APR runs out. It’s free money!”

Credit cards are not “free money.” In fact, if used incorrectly, they are some of the most expensive sources of money out there.

In 2016, the average American household had $16,425 in credit card debt and paid over $1,200 in interest per year.

And yes, these households include people who spent over their means. Maybe they bought “too much stuff,” or maybe they had an unexpected expense and used their credit card as an emergency fund.

(We don’t judge.)

But these households also include the people who put their vacation on their 0% APR cards and don’t pay off their balance in full. They include the people who use high-rewards travel cards to get a free round-trip flight and then pay more than the cost of the flight in interest because they didn’t take the time to understand how the credit card worked.

They include all of the people who thought they could make credit cards work for them and then found themselves working to pay off their credit card debt.

If you play it smart, there’s no reason to be afraid of credit cards. In fact, when used the right way, credit cards can significantly improve your life. Lenders, landlords, and employers often check credit histories or credit scores, and being able to prove that you can handle credit without running up debts can help you get that dream apartment or lower interest loan.

Choose Your Cards Carefully

You know that moment when you’re buying clothes, for example, and the person at the register asks if you’d like to save 15 percent RIGHT NOW by signing up for a store credit card, the credit card companies know that if you do, you’re very likely to end up owing them a lot more money than you’ll save on that cute top.

(It is a cute top, by the way.)

That savings can be great! It’s just important to understand how your new card will work because if you don’t… you might end up paying more. Before signing up for any credit card, you need to take a careful look at its terms:

APR: This is the annual percentage rate of interest that you’ll be charged for any balances you don’t pay off in full by your payment due date. Lower APRs are better.

Intro APR: Credit card companies love to offer a limited-time APR that’s much lower than the card’s actual APR. This is where you see those “0% APR for one year” cards. You might think you’ll pay off any charges you make before the intro APR runs out — and maybe you will — and you’d be wise to stick to that plan, so you don’t end up paying more in interest.

Fees: In addition to charging interest, credit card companies at times will also charge additional fees. They might charge a fee if you make a late payment, for example, or for putting too many charges on the card and going over your limit in a given month.

Many credit cards charge fees for balance transfers. That’s when you transfer money you owe from one credit card to another in the hopes that you’ll pay off all that money someday.

They also have fees for foreign transactions. That’s when you use your credit card to buy an 18-inch replica of the Eiffel Tower because you’re only in Paris once.

(P.s. The 6-inch one would have been better. Where are you going to put an 18-inch Eiffel Tower?)

Some people may not be aware of their card’s fees — which we know you’re not going to look into in a busy checkout line. So always make sure to read the fine print!

Rewards: Here’s the part where everyone suddenly starts paying attention. Yes, credit cards offer a lot of rewards — maybe you get 5% cash back on groceries, or maybe you get 30,000 bonus miles if you make $1,000 in purchases in three months.

Credit card rewards can be confusing, and they are always tied to spending money on the credit card. You can’t get that 5% cash back on groceries unless you pay for your groceries on credit, right? And sure, you’ll pay the card off in full by the end of the month.

Unless something unexpected happens. Like… your dishwasher stops working.

But let’s say you’re going to use credit cards responsibly. You’re going to only make purchases you know you can afford within your current budget, you’re going to pay them off in full every month, and you’re

going to have a savings account or emergency fund so you can pay your credit card off in full even when something unexpected happens.

What kind of rewards can you earn?

Everything You Need to Know About Credit Card Rewards

Credit card rewards can be divided into two major categories:
Cash Back: For every dollar you charge to the card, you get a percentage of that dollar “back.”

But it’s not always like getting 5% cash back on a $100 grocery purchase means your groceries only cost $95. A number of credit cards don’t give you that cash back right away.

Most credit cards will give you multiple redemption options: maybe you want your cash sent to your checking account, maybe you want to convert it into a gift card, or maybe you want to use it to pay off part of your credit card balance.

(Guess how many people use their credit card rewards to help pay off their credit cards.)

Credit card cash back rewards often come with caveats. Some cards use what are called “rotating categories;” i.e. every few months, a different category of purchases get the BIG rewards — like “restaurants” might earn 3% in May and “gas stations” earn 5% in February — while all other purchases earn a smaller reward.

Many cards also set limits on the amount of cash back you can earn. Maybe you can earn cash back on the first $6,000 in purchases you make every quarter, and then all purchases after that earn 1% cash back.

(Am I the only one or is that a little confusing?)

Other credit cards offer a single cash back percentage, with no categories, tiers, or limits. For example, PayPal — who is graciously sponsoring this article — is introducing a new Cashback Card that provides a simple 2% cash back on all your purchases, redeemed directly into your PayPal account balance.

Whatever you choose, make sure to do your homework and read the fine print carefully.

Points and miles

Credit cards that don’t offer direct cash back often offer rewards in the form of “points” or “miles.” Earn three miles for every dollar you spend on your airline credit card, and eventually you’ll earn enough miles for a free flight!

(Yes, some credit cards have online catalogs where you can spend your points. There’s some cool stuff in there, too — and if you don’t need stuff, you can usually turn your points into a gift card.)

As with cash back rewards, there are rules and limits on the number of miles and points you can earn. Some purchases are worth more points than others. If you have an airline credit card, you’ll get more miles buying a plane ticket than you will buying groceries.

Once again: do your homework and read the fine print carefully.

Here’s a perfect example of doing that homework: If you’re getting an airline credit card for the miles, you should already be flying that airline pretty much exclusively. If you’re one of those people who searches discount flight sites and will fly any airline that’s offering the lowest fare — even if that means being crammed so close to your neighbor that you can tell what they ate for breakfast — an airline credit card is probably not the best credit card for you.

So How Can You Use Credit Responsibly?

The best way to use credit cards responsibly is to always pay your balance in full, every month.

We know that most of you aren’t going to do that. Even those of you who pay your balance in full 99% of the time might have one month where you just can’t.

Because your dishwasher broke or your washing machine and your air conditioner all stopped working at once.

If your credit card offers rewards, don’t get so excited about the rewards that you put more charges on the credit card than you can pay off. Just because you can earn 3% cash back on up to $6,000 in purchases doesn’t mean you need to make $6,000 in purchases.

If you have bad credit, you’ll have fewer credit cards available to you, and they’ll probably have higher interest rates. That’s okay. Making small purchases on those credit cards and paying them off in full every month will help build your credit score and make better cards available to you.

If you already have credit card debt, it is possible to transfer your debt to a credit card with an intro 0% APR and pay it off interest-free. Yes, you’ll pay a balance transfer fee as part of the process — but if your credit card debt is costing you a lot in interest every month, it might be worth it.

Just make sure you pay off the card before the 0% APR runs out.
And yes, it is even possible to fund your vacation with a 0% APR credit card and pay it off interest-free. But that only works if you know how to use credit responsibly.

Money IQ is a publication that aims to provide simple, no-nonsense personal finance advice. We’re here to dispel myths and demystify personal finance for our readers.